Has the seemingly never-ending growth story of the Chinese economy now hit a roadblock? More important, is the hit on the real estate giant so strong that the Chinese growth story may take a backseat now? China watchers are cautious — some cautiously optimistic and others, who are hoping for a Chinese slump, are not very confident either. In short, what the Evergrande failure to service its debt brought to the fore is something many suspected but never had any proof in a carefully information-controlled state. The question that is not asked is if the shrewd autocracy in Beijing would let the Evergrande default hog the global headlines in order to hide something more noxious. The answer lies in the warning signals indicating how deep-rooted the Chinese malaise is.
First, look at the headline news of the Evergrande default and the aftermath. Goldman Sachs has become the latest bank to cut its China growth forecast; it is now expecting zero gross domestic product growth in the third quarter. Many other top bankers like Nomura, Morgan Stanley and the top rating agencies have expressed concern about the Chinese economy. Apart from Goldman Sachs predicting flat third-quarter GDP growth, year-over-year (YoY) growth forecasts were cut by most analysts and banks, all describing China’s debt crisis and energy constraints as a “growth shock”. “Recent sharp cuts to production in a range of high-energy-intensity industries add to the already significant downside pressures in the growth outlook,” said an analyst. They noted that “considerable uncertainty” remained heading into the fourth quarter, most notably how the Chinese government approaches managing its debt crisis.
Two problems have hit China hard. First came the debt crisis of its property giant Evergrande, the second-largest real estate company in China. The second is the energy crisis. A couple of years ago, Evergrande was the world’s most valuable real estate stock. The property giant diversified into a mix of other businesses, from mineral water to electric cars to pig farming. It even owns a professional soccer team and is busy constructing a football stadium. But now it finds it difficult to service its $330 billion worth of debt.
The Evergrande story is bigger than just one company. It’s about China’s unsustainable model of economic growth, which has relied on endless investment and a mad, debt-fuelled development frenzy in recent years. That model helped China soar, but the country is now experiencing turbulence. Last week, some alarmist observers were calling this China’s “Lehman moment” — a reference to the collapse of Lehman Brothers that preceded the 2008 financial crisis. But the observation is myopic at best as, in August 2020, Beijing had announced its “three red lines policy” initiatives to ensure a soft landing of its overheated housing property market. The effect of this policy saw Evergrande default and another developer Sunac face trouble. Beijing is ensuring a transition from the bubble economy that depended on unsustainable debt and a continued flow of funds to shake the belief that “real estate prices can never fall” — it is, judged by policy turns since at least August 2020, a planned move from the overheated brick-and-mortar economy to a modern digital one. Evergrande default should be read in this context.
President Xi Jinping has a vision of China 2025 to ensure the Chinese predominance in new technologies, from artificial intelligence to robotics. Such a move would ensure Chinese dominance over the global economy as also its control over local and global politics. As an analyst felt, “Big Data, fed by the internet and the hundreds of millions of public cameras, will support Xi’s surveillance society.’ And this will be a global surveillance society. Evergrande could be a distraction for the global think-tank.
That the Covid-19 crisis that has impacted the global economy has not spared China is evident in its recent PMI (Purchasing Manager Index) data. In September, Chinese manufacturing PMI fell below 50 to 49.6 against 50.1 in August, the first slippage to the contraction mode since February 2020. More crucial is the sharp drop in the high energy-consuming industries processing metals and oil due to the energy crisis faced across the country. The Chinese economy is evidently hit by wider curbs on electricity use and higher input prices. The energy crisis is the second problem that China faced after the bursting of the real estate bubble.
A shortage of coal, tougher emissions standards and a strong demand from manufacturers and industry pushed coal prices to record highs and triggered widespread curbs on electricity use in at least 20 provinces and regions. Higher raw material prices, especially of metals and semiconductors, have squeezed the profits of manufacturers too. Earnings at China’s industrial firms in August slowed for the sixth straight month.
The power situation is worrisome. Factories in 20 of China’s 31 provinces faced power outages, forcing many to shut down production. Millions of households in the northeastern parts of the country have also suffered a power crisis and failed to heat or light their homes. As winter comes, the situation may turn worse. Among the prized factories — that of Tesla as also suppliers of Apple — faced a loss of production due to power cuts. Beijing’s effort to emerge perhaps as a global leader on environmental concern introduced several restrictions. This coupled with the global rising price of coal and the wish list of the power producers to wait to restock coal till the price comes down created the present imbroglio. China is now witnessing the rationing of electricity to its productive and domestic users — a severe jolt to the shining Chinese success story.
When troubles swept under the carpet by an information-deficit country start tumbling out, the government runs like a headless chicken. The Chinese president had a rude awakening from his dream of global dominance. He is reluctant to eat the humble pie and smoke the peace pipe with Australia and resume importing coal from there. It will be a loss of face for him to climb down from the lofty chair of an environmentalist and burn coal to avoid the collapse of an economy built on copying, polluting and use of the neo-slavery technique of labour management. Xi cannot enrage people now accustomed to certain basic comforts like electricity at a low cost. Hence the instruction to the power sector not to raise prices despite the higher cost of coal and this introduced rationing. The domestic boom built on easy finance and spiralling debt, as also export earnings, ran out its course, thanks to a shrinking global market and excess debt at home. What is more, there lies the carefully hidden fact — that of a huge pile of debt of its local governments.
The innovative system of local government financing vehicle (LGFV) had run its course beyond the tolerance level of even a Beijing where Xi is aspiring for global leadership. Chinese banks and insurers were seen connecting their systems with a platform of the Ministry of Finance that monitors liability and expenditure of LGFVs, reported Securities Times and was splashed by Reuters in July. Goldman Sachs reported that China’s hidden local government debt had burgeoned to more than half the size of its economy. Local governments’ outstanding debt was huge, standing at 25.7 trillion yuan ($ 3.97 trillion) at the end of 2020. But the quantum borrowed through the innovative LGFV window remained hidden. Nomura estimated in a note in April, as reported by Reuters, that local governments’ hidden debts reached 45 trillion yuan in 2020-end. Goldman Sachs reported that the total debt of local government financing vehicles increased to about 53 trillion yuan ($ 8.2 trillion) at the end of 2020 from 16 trillion yuan in 2013.
Add the huge fund advanced to many low-and middle-income countries (LMICs) even as the entire lending operation remained shrouded in secrecy. A recent research report captured 13,427 projects worth $ 843 billion across 165 countries in every major world region. It observed an extraordinary expansion in China’s overseas development finance programme during the first two decades of the 21st century. China’s annual international development finance commitments hovered around $85 billion a year, thus it outspends the US and other major powers on a 2-to-1 basis or more. Initially, a majority of its overseas lending was directed to sovereign borrowers, but after the introduction of BRI (Belt and Road Initiative), nearly 70% of funding is now directed to state-owned companies, state-owned banks, special purpose vehicles, joint ventures and private sector institutions. These debts, for the most part, do not appear on government balance sheets in LMICs and are kept hidden from multilateral institutions and public glare. Most of the money lent, given the global economy post-Covid, can safely be assumed is now lost. In short, any careful analysis will reveal that China’s problems are much bigger than the mere bankruptcy of Evergrande. Its ambition to replace the US as the global economic powerhouse is now shaken, whether or not the information-shy country admits it. How President Xi manages to rerail the economy and strengthen his sliding position in power will be an interesting case study for China watchers.