China : Xi JinPing at the Crossroads of Prosperity and Ideology
The Evergrande crisis — a private Chinese real estate company unable to face the service of its $305 billion debt — represents a milestone in the internal ideological fight of the Chinese State Council.
A paper tiger: the exploding debt
It is generally admitted that China considers the Western Hemisphere as vulnerable and challengeable without much risk.
In the economic and financial world, however, there is ample evidence of a weakening China. At the core of this weakening is the Chinese indebtedness. The country is facing a dual risk. The national debt has doubled in the past five years and is expected to quadruple in the next ten years. This debt is widely owned by banks and the People’s Bank of China. Furthermore, it represents only 70% of China’s GDP, twice the US ratio.[1]
This, however, is only part of the story. The indebtedness of the private sector has increased even more significantly. Corporate debt (including State Owned Enterprises), currently accounts for over two thirds of the total debt, standing at 182% of GDP. This is more than 2x the amount of corporate debt in advanced economies, and more than 3x that of emerging market economies, excluding China.
Cutting off links with foreign capital markets?
It was Donald Trump who, in his infinite ability to weaken the international standing of the United States, launched the first attack on the Chinese companies connected to the People’s Liberation Army. Trump delisted these companies from US exchanges who, complacently, obliged an executive order one month before the election.
Whether it was the reason or a pretext for Chinese authorities to limit the access of Chinese companies to global capital markets does not change one basic fact: The People’s Republic of China does not have internal sources of capital to finance its prosperity.
China’s regulator expanded the investment scope for foreign investors, adding key commodity and stock market derivatives in the latest move to open its financial markets even as Beijing’s crackdown on a broad section of its private sector has roiled markets. [2]
This one-sided policy is interesting: China is willing to let foreign investors invest in China, but not in foreign capital markets. Goldman Sachs Group announced it had received approval to take full ownership of its securities venture, easing its push to expand in China.
The key to this policy is control, not value. The China ADR Index dropped almost 50% since the beginning of the year. This drop makes the cost of funding of Chinese companies twice as expensive as in two years ago.
The e-Yuan is a domestic control tool
The promoters of Central Banking Digital Currency have taken their cue from the Chinese e-Currency. The e-Yuan will allow the Chinese authorities to have tighter control over the assets of the people, with the assistance of the local banks.
The e-Yuan will not be accessible to foreign owners, not even to accredited foreign investors. It will therefore have zero effect on the internationalization of the Yuan. In a recent study of the Asian Development Bank Institute, the authors conclude that the PRC’s growing economy and trade volume are favorable conditions for internationalization. However, other conditions, such as the existence of deep and liquid financial markets, have not been met. To create conditions for the internationalization of the yuan, the PRC government should encourage financial markets to play an increasingly important role.[3]
The PBOC balance sheet has reached $6 trillion and is equivalent to the largest central banks. It is mostly funded by the reserves of the banking sector: does China intend to disinter-mediate its banking system and threaten their financial stability?
It’s all a question of trust — the Evergrande question
China wants to be treated as a fair partner in international trade. Its WTO membership has been a true achievement for the country and international commerce. What can be done to further open up the Chinese market under the existing WTO regime? ‘Not much’ is the simple answer. There is a lot in terms of ‘spirit’ but no binding language in the Protocol of Accession. [4]
Trade and Finance go hand in hand. The Evergrande case shows the difficulty for President Xi JinPing to strike the right balance to enhance international trust in the country. “Only” $20 billion of the Evergrande’s $305 billion debt is in foreign currency, and even part of it is in Chinese Banks’ hands.
The Chinese regulatory system and oversight is politically influenced. Will Evergrande be allowed to transform itself from a real estate group to an Electric Vehicle company? There is no alternative to an orderly liquidation of the company. Debt restructuring will require negotiation and the company should be stripped of all its non-real estate assets. More importantly, a rigorous oversight mechanism needs to be implemented.
Defaults on bonds and loans have been happening in the past years in China. The idea that the government will bail-out any private company is unfeasible. China has reached the limit of its leverage and trust in capital markets needs to be rebuilt and restored.
Closing the doors will only increase the current mistrust.
An opportunity for the Biden Administration?
Secretary of State Anthony Blinken in his policy statement was clear. Our relationship with China will be competitive when it should be, collaborative when it can be, and adversarial when it must be. [5]
Where do capital markets and finance fall? It seems to me that it should be collaborative in its essence because financial stability, efficient capital markets and financial resources are, in an interconnected world, a common good. No country will survive a looming global financial crisis without having built solid cooperation between Central Banks and Governments.
I would argue that this is an opportunity for the Biden administration (who seems focused on the adversarial part of this critical relationship) to extend an olive branch and depoliticize financial markets.
[1] https://www.statista.com%2Fstatistics%2F531423%2Fnational-debt-of-china%2F&psig=AOvVaw0iyS87sbH11yyJUO1Z4DP5&ust=1635255465031000&source=images&cd=vfe&ved=0CAkQjhxqFwoTCOCO07rX5fMCFQAAAAAdAAAAABAD
[2] https://www.bloomberg.com/news/articles/2021-10-18/china-opens-stock-commodity-derivatives-to-foreign-investors
[3] https://www.adb.org/sites/default/files/publication/156221/adbi-wp366.pdf
[4] https://voxeu.org/article/china-and-wto-uneasy-relationship
[5] https://www.state.gov/a-foreign-policy-for-the-american-people/
