BackEvergrande: China may have left the barn door open for too long
Debt levels may have already been too high by the time Beijing placed curbs on over-leveraged firms
PremiumOn Friday,The Wall Street Journal reported, citing “people familiar with the matter", that Evergrande had failed to make its coupon payment on a US-dollar bond. What is not clear, at the time of writing, is if it missed the payment on a domestic bond as well on Thursday (23 September).
There is a mixture of hope and opinion that Evergrande would not turn out to be China’s ‘Lehman moment’ for the simple reason that China can simply order its banks to start lending to the real-estate company and all would be well. The truth is that ‘nobody know anything’ (on.wsj.com/2XYdBQk). None of us know the extent of the rot inside Evergrande. According to a report published in 2016, the company had almost 400,000 car parking spaces on its balance sheet valued at $7.5 billion, roughly equivalent to its entire equity base (on.ft.com/3lYsnPf). Further, if Evergrande hid its debt, as Caixin reports, why not other firms?
After all, one year ago, no one really predicted that Evergrande would come to this state and that there would even be newspaper reports that the Chinese government would let the firm collapse. Nor did economists, stock market analysts and commentators predict the turn that China’s economic policy would take from last year onwards. Therefore, when it comes to China, we must take most expert opinion as no better than the ‘knowledge’ we derive from “WhatsApp University", as the online quip goes.
That said, the long read authored by James Kynge and Sun Yu for the Financial Times is perceptive (‘Evergrande and the end of China’s ‘build, build, build’ model’, 22 September). It is still not too late to read Kynge’s book, China Shakes the World, first published in 2006. The book was a revelation. His and Yu’s article touches upon the impact of Evergrande and other developments on China’s economy and its potential growth in the years ahead. Its potential annual growth could decline to between 1% and 4%. Together with a declining birth rate and lower migration to urban centres, land sales by local governments could fall, drastically curtailing a big source of revenue for them. Their overt and hidden debt could make Evergrande look like a paragon of financial virtue.
China’s “three red lines" announced last year came in the way of Evergrande not being able to raise further debt. Specifically, these red lines insisted that a company’s ratio of liabilities to assets be below 70%, its ratio of net debt to equity be below 100%, and that its ratio of cash to short-term debt be at least 100%. In June, Evergrande was failing on all three metrics and hence it was not allowed to raise further debt. Even if the three red lines are now erased or diluted, will Evergrande be able to raise money?
Perhaps, it might be able to because global financial interests still adopt an attitude of ‘hear no evil; see no evil; think no evil’ towards China. The FT notes that both Blackrock and HSBC added to their holdings of Evergrande debt in recent months (on.ft.com/2XV2nfK). It could be either myopia or self-preservation instincts at play here, because they cannot afford to abandon the ship now without writing off a substantial chunk of what they had invested already.
At one level, what Beijing is doing with respect to its economy is deep structural reform of the kind the West does not seem capable of anymore. Washington dare not draw the three red lines that Beijing drew for over-leveraged sectors and firms. If too much debt and too much investment have driven growth and if it happens to be unsustainable, then the only way out is to take the pain that comes with reversing course, but that is the right thing to do.
The problem with this relatively constructive view of what Beijing has embarked on is that it has simultaneously chosen to attack many sectors. Again, taken in isolation, each of its regulatory actions might be considered necessary and appropriate. Collectively, however, they might choke off animal spirits in China’s economy.
It is one thing to reassure the world that the government is not about to kill the private sector. But, if the private sector is now only meant to implement the ideas, plans and orders of China’s Communist Party, is that truly a market economy?
There is a risk—and it is non-trivial—that China might have bitten off more than it could chew, given that Beijing has opened too many fronts, globally and locally, in the past few years.
Internationally, it had burnt many diplomatic bridges over the years. Its non-cooperation with the rest of the world on the origins of the covid virus has not removed misgivings even among neutral minds. In its domestic politics, we don’t know enough about how much internal dissent and unease is brewing.
The resulting combination may be too much to handle for the country’s leadership, or it might have to resort to severe repression to contain incipient protests and popular unrest. Both are unlikely to have a good ending.
So, the sanguine attitude in financial markets speaks volumes about the power of the liquidity that has been unleashed by central banks. It speaks to the extent of the intertwining of global finance with Beijing. Lastly, it speaks to the pervasive myopia and the lost art of pricing risk in financial markets. That, of course, is not just with respect to pricing in the China risk.
V. Anantha Nageswaran is a member of the Economic Advisory Council to the Prime Minister. These are the author’s personal views.
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