Evergrande crisis highlights China’s shortcomings
VSVASTE OF HINA and the opaque financial system has long been a threat to its economy and the world. The anxieties of Evergrande, a real estate company with huge debts, are a reminder of how difficult it is to manage risk. The government is trying to impose an orderly default on some of its creditors but faces the risk of contagion. The episode also sheds light on a larger question of whether President Xi Jinping’s crackdown on businesses will make it even more difficult to create a reformed financial system that is safer, more open and more efficient.
Part of what makes the Chinese financial industry intimidating is its size. Bank assets have swelled to around $ 50 billion and they rub shoulders with a large Byzantine system of parallel financing. Total loans to businesses and households increased from 178% GDP ten years ago at 287% today. The industry suffers from opacity, a lack of market signals and erratic rule enforcement. Ownership is part of the problem. Families funnel their savings into apartments rather than casino stock exchanges or state banks. Real estate developers are taking on debt in the shadow banking system to fund epic construction booms.
In addition to being large, the system is inefficient in allocating capital, which hinders growth. It is also not a problem that the world can ignore. Chinese companies have issued around $ 1 trillion in dollar bonds, many of which were bought by foreign investors. A shortage of liquidity in the Chinese economy would hurt global activity, from commodity markets to sales of luxury goods.
With an illiquid portfolio of real estate projects funded by $ 300 billion of liabilities, 80% of which are short-term, Evergrande has a huge liquidity imbalance. He has struggled to cope with new government rules designed to curb excessive borrowing in the real estate sector, but which may now have had the opposite effect.
Bailing out financial firms can be unpleasant but necessary – just ask the officials who saved AIG and Citigroup. The Chinese government fears that a default could cause contagion in the bond market and shadow banking sector and lead to job losses and stalled projects in the real estate sector, which underpins around a fifth of GDP. At the time of going to press, it was not clear whether the government would blink and save the company.
While the “too big to fail” dilemma is common, many elements of the Evergrande saga highlight China’s shortcomings. Evergrande’s claims about whether he missed any interest payments have been confusing, leaving investors in the dark. It is not clear whether the formal hierarchy of creditors matters or whether the Communist Party’s perspective on who counts will prevail. The sense of opacity and political machination is part of a pattern. Huarong, a public finance company victim of fraud, hid a loss of $ 16 billion for months. She was finally refloated in August.
Evergrande shows the importance of deeper financial reforms. But what could they look like? Liberal reformers aspire to bad debt consolidation, relaxation of price controls (including the exchange rate), transparency, and independent courts that can enforce property rights. Such a system would allocate capital better and be less prone to moral hazard.
Xi’s authoritarian regime contributes to financial stability in a way: it views excessive borrowing as a security risk and can terrify debt-hungry tycoons to become more cautious. Centralization of power can make it easier to control crises in sprawling organizations like Evergrande.
But his broad agenda to reassert control over the economy, information flows, courts and regulators runs counter to the direction of financial reform. Why would he want a more open capital account, which would increase the risk of capital flight following political purges, or private creditors having stronger rights, or delegating the role of choosing the industries of tomorrow to investors? ? Even if Evergrande escapes calamity, the consequences of Mr. Xi’s policies for the long-term health of the financial system are only beginning to be felt. ■
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This article appeared in the Leaders section of the print edition under the title “Bail-outs and bedlam”