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Communist China’s ‘Lehman’ Moment?

C. K. Saji Narayanan

C. K. Saji NarayananOct 04, 2021, 03:35 PM IST

Communist China’s ‘Lehman’ Moment?

Two decades after Communist collapse, capitalism is also facing serious crisis. China’s Evergrande crisis shows even the cocktail of ‘market socialism’ isn’t working

 

Evergrande, a company which started selling bottled water in 1996 entered the real estate sector, became one of the largest real estate developers in China with its headquarters in Shenzhen. It is one of the world’s biggest businesses by revenue. It has expanded to about 250 cities in China selling skyscraper buildings and apartments.Apart from the housing sector, the company invested in electric vehicles, sports, food and beverages and other goods. It also established theme parks by name “Fairyland” and took possession of Ocean Flower Island in Hainan known famously as “Chinese Hawaii”. It directly or indirectly engages nearly 3.8 million jobs every year. The company had a favourite presence in the capital market of Hong Kong.

Its founder Hui Ka Yan was considered a high-profile tycoon with wide political connections. He was given coveted seats in official celebrations and respected even more than Jack Ma, the founder of Ali Baba group. He was known as the country’s most charitable person who spentnearly 465 million dollars as donation in a short period. Hui even owned “Guangzhou Football Club” and China’s top soccer team that is now known as “Guangzhou Evergrande”. Further he established the world’s biggest soccer school, and is in the process of building the world’s biggest soccer stadium. 

Fall of the Goliath 

The fall of the giant started when the company deviated too far from its core business. But the crisis of Evergrande did not surface on a fine morning; it was brewing for a long time.Regulators were warning about its huge debt liabilities that doubled up during the period from 2016 to 2020 to about 305 billion dollars. Company could somehow cover it up until recently when the group failed to pay even the interest on a two-billion-dollar bond that matured. Its shares plunged to over 11 years low. It failed to raise funds to pay its lenders, banks, suppliers of materials, investors and bond holders in the midst of increased borrowing to finance its activities. Its debt liabilities are spread among 128 Banks. Today it is the world’s largest indebted real estate company. Buyers shied away from purchasing the group’s apartments, assets and electric vehicles for various reasons. The reasons included slowdown in China’s property market and tapering demand for new houses. Nearly 800 unfinished buildings are waiting for home buyers apart from a large number of half-finished homes.

When Evergrande ran out of credit, the Chinese Government decided not to save it by any bailout package or further credit. People who have bought unfinished apartments, construction workers, office staff, suppliers of materials, small investors, etc., have become orphans and are now protesting in front of its headquarters.

China very much relies on debt fuelled investments to catalyse growth, which has raised fears now. Whenever China felt a slowdown, it turned to the unsustainable model of resorting to debt to boost growth. People are also prompted to save less and spend more

Many analysts have termed the crisis of Evergrande akin to the fall of Lehman Brothers in the US that surfaced during the Global Financial Crisis of 2008. Many global giants numbering to 500 richest companies have thoughtlessly invested to the tune of 135 billion dollars in Evergrande which includes Elon Musk with 7.2 billion dollars and Amazon with 5.6 billion dollars. This exposes the fallacy of the world-renowned analysts and rating agencies in assessing corporate performance. James Mackintosh writes in The Wall Street Journal that he expects “more Evergrande-like mistakes” in China’s economy. Like Lehman collapse, the fall of Evergrande was also totally unbelievable for most. Investors across the world are worried that the crisis may turn out to be a potential contagion like the 2008 Global Financial Crisis related to a subprime mortgage crisis.The US treasury Secretary has warned of an “economic catastrophe” if urgent measures are not taken.

China’s Flawed Economic Model

The Evergrande fall is not an isolated phenomenon in China’s economy. Analysts of Nomura Holding Inc., including its Chief China economist Ting Lu predicted that China’s economy will shrink.In 2020 a batch of state-owned companies defaulted on huge loans. Huarong, China’s state-owned financial company is in a crisis with a 240-billion-dollar debt.China has implemented a bailout to save it. For years China has been trying in vain to clean its bad corporate debts. It has caught hold of companies which borrow heavily to explore fortunes in the global market.

The basic problem with China’s economic growth is its defective economic model which is largely being questioned by many. Many analysts point out, “Borrow to build” is the core of China’s economic model, which has displayed its fragile nature today. 

Evergrande is termed the Chinese economy in miniature. It reflects the flaw in China’s fragile economy. The Bank for International Settlements points out that China (including Hong Kong) along with Greece and Singapore have non-financial debt of more than 100 per cent of GDP since 2011.During the last several years, while other countries have reduced their debt levels, China has been increasing its borrowings. No other major economy in the world has such a huge debt level proportionate to the GDP as China has. The casualty of  contagion will be the banking sector, which can trigger a  financial crisis. 

The impact on India may be minimal. Indians in China are engaged in comparatively better sectors like clean energy, semiconductors, footwears and chemicals. We are not largely exposed  to China’s riskier finance and  property sectors

Another Crisis in Power Sector 

China faces another economic shock, the widening power shortage acutely affecting industrial areas like Jiangsu, Zhejiang and Guangdong which account for one third of its economy. China has curbed power use in major manufacturing hubs. It had halted production at a number of factories thereby hitting the manufacturing sector and associated supply chains.Nikkei,the suppliers to Apple Inc, Tesla inc, etc. stopped production recently in some cities of China. Rising domestic and industrial demand for electricity, increasing price of coal, gas etc and Government’s decision to cut emissions are accelerating the crisis. President Xi Jinping wants to show the international community that he is serious about decarbonising and emission cutsin order to guarantee “blue skies” during the Winter Olympics to be held in Beijing next February. Home heating during the coming winter will be affected by power ration implemented by a communist dictatorial regime.Cities have turned off their street lights. Many experts warn that it is going to adversely affect the industrial sector ranging from textiles to electronics. Power cuts have affected China’s giant food sector firms, many of which were ordered to be shut down as in Tianjin city. Steel mills in the major economic province Jiangsu were closed. Nomura’s China chief Ting Lu commented: “Very soon the global markets will feel the pinch of a shortage of supply from textiles, toys to machine parts."

Crisis Starts Impacting

Impact of the turmoil is getting visible in China’s economy. Finances have started fleeing from other property companiesin China. Housing and land prices have crashed. Supply of building materials like concrete, steel, pipes, wire and others have crumbled. Unemployment soars. Countries like Australia and Brazil which supply coal, iron ore and other raw materials to Chinaface a set back and will have to sell their products for cheaper prices to other countries. 

The impact on India may be minimal, experts say. Indians in China are engaged in comparatively better sectors like clean energy, semiconductors, footwears and chemicals. We are not largely exposed to China’s riskier finance and property sectors.India’s iron ore and steel sectors are under pressure even before the recent crisis due to China’s emission cut measures. We have already cut certain imports from China during the pandemic.India may experience an increasing shift of capital flows to it due to the current turmoil in China.

Is it the Beginning of China’s Fall?

Many have come to the conclusion that the fall of Evergrande is only a tip of the iceberg. According to Mark Williams, Capital Economics’ chief Asia economist, the fall of Evergrande “would be the biggest test that China's financial system has faced in years.” Thirty percent of China’s GDP is accounted for by real estate and related industries. China’s post pandemic economic sustenance was enthused by a surge in property prices. “The story of Evergrande is the story of the deep (and) structural challenges to China’s  economy related to debt,” says Mattie Bekink, China Director of Economist Corporate Network. The current crisis is seen as a result of a systemic flaw appearing in China’s financial system. Even Chinese media dub it as “a huge black hole,” indicating nothing can save it. Evergrande’s fall is taken as a reflection of the shaky state of the world’s second largest economy,which may ignite a larger crisis in its financial system, if miracles do not happen. 

 

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