China struggles in a more divided world

As Chinese property group Evergrande buckles under the weight of more than $300bn of debt, problems for Beijing are intensifying.

| 4 min read

China’s retail sales managed a year-on-year increase of just 2.5% in August, and industrial production rose just 5.3%. The economy was slowing anyway under more cautious monetary and fiscal policies, only to encounter a surge in Covid-19 infections.

China has responded with strict lockdowns in cities affected, hitting output and some container traffic from docks. This huge country is now getting on with vaccinating many more people which should allow the resumption of more social contact and trade in affected areas in due course. Some modest reflation is being attempted through lowering the controls on the volume of bank lending. The central bank may also provide more liquidity to deal with obvious stresses.

More serious is the darkening news from Evergrande. This huge private sector conglomerate company has a big position in the provision of housing for better-off Chinese and has branched out in a range of property and industrial activities from its residential property base. It has debts as large as $305bn and is finding it difficult to service them.

Severe financial strain

Various programmes of asset sales and equity fundraisings have been attempted, but the financial pressures remain severe. The China Banking and Insurance Regulatory Commission announced its formal talks with the company in August and said then that it wanted better disclosure from the company of its financial position without any false information. The company is involved in asset management products, where individuals place their funds into managed products that may invest in property and property debt. We have recently seen harrowing scenes of investors demanding their money back in the company offices and explaining how their lifetime savings have been placed at risk.

The regulator has been well aware of the hazards in the shadow banking sector. It has been trying for some time to control it, limiting the risk of managed financial products, demanding transparency over what funds invest in and seeking clarification of the claims made for the products. The English translation has called it “chaos rectification” from stronger internal controls and greater disclosure from this sector.

On 10 June the regulator clearly warned: “Credit risks facing the banking institutions are on the rise due to housing bubbles and housing-related financial products in some regions, debt service pressure of a number of local government financing platforms and the default ratio of some large and medium-sized corporations. The situation for some small and medium-sized institutions is more severe”. They want to put an end to all loan-like products that are circulating in the murkier recesses of the financial system.

The regulator makes clear they are following President Xi Jinping’s policy and guidance and are keen to press on with a general clean up. The new policymakers seeking common prosperity are not so worried if rich individuals lose money or if large private-sector companies are humbled.

It is difficult to judge how far they will go in allowing the collapse of shadow banks, smaller banks and property companies. They are likely to support state-owned enterprises and large banks, understanding systemic risks and wanting to show how much safer the state sector is. They are unlikely to worry too much about these more entrepreneurial groups defaulting on foreign currency paper. We should expect some damage to flow from the Evergrande troubles into both the Chinese domestic shadow banking and small banks sector, and into the high-yield overseas bond markets.

Political strain on the rise

Meanwhile, the decision of the US and the UK to share their technology with Australia to allow the Commonwealth country to acquire nuclear-powered submarines has been taken badly by China, which accuses the West of seeking a new cold war.

Only the US, UK and France, and India, Russia and China have nuclear-powered submarines to date. These powerful vessels are greatly superior to conventionally powered submarines. They can stay submerged for long periods and are far more difficult to detect because they are quiet and can run deep.

The West says they will help police the sea lanes and reinforce open trade. China’s ambitions for the South China Sea may be the reason it takes this move so badly. The growing distrust matters to markets and may have a knock-on effect on how China deals with its largely private sector $2.4 trillion foreign debts.

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China struggles in a more divided world

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