The Chinese Long Shadow
A specter is haunting the world – the specter of Chinese indebtedness.
Xi Jiping, president of the People’s Republic of China, has had a rough couple of years. Even without Donald Trump raising the stakes of the trade war day by day, the Communist party leader is at helm of a $12 trillion economy. His goals are not easy: keep growing at the extraordinary pace of the last decades, resisting the physiological slowdown, expand the influence of Beijing all over the world – as a global superpower is supposed to – and, obviously, prevent a financial collapse.
As trivial as it may seem, mentioning the last point is necessary. The Bank of the international settlement, earlier this year, has enlisted China among the countries more exposed to a potential banking crisis. Even if Xi Jiping consequently pledged to keep the total debt to GDP ratio stable for 2018 (i.e. at 260 percent), the leverage of Chinese enterprises remains as one of the ten most probable triggers of the next global crisis, according to a recent article by NYU professor Nouriel Roubini.
Some measures have been taken. A grand state-enterprise reform is underway, in which regulators are trying to spot centrally-managed zombie companies, close them and write off their debts from Beijing massive balance sheet. Policy makers are also trying to reform and downsize the investments of bank local branches for the redevelopment of peripheric areas and cool down the housing market.
However, not all policies seem to go in this direction – actually, there is quite a significant divergence. This summer, the POBC raised the credit growth caps that it confidentially imposes on each bank in order to boost the economy and counteract the potential negative effects of the trade conflict with the US. The shadow banking system as well is being encouraged to sustain infrastructure construction.
Significantly, infrastructure investment itself has experienced a greater-then-expected slowdown recently, and seven local government financing vehicles have been downgraded by S&P. Some investors must be expecting defaults, sooner than later.
At the end of the day, Beijing’s ultimate goal is to become ever less dependent from exports and develop the domestic market. The politburo has been down this road ever since the financial crisis: after Lehman, exports fell by a third or, in other terms, by 10% of GDP. Beijing still managed to grow at a rate above 9% in 2008 and 2009 thanks to an unprecedented increase of public spending, worth 12.5% of GDP. Even if the Asian juggernaut remains, together with Germany, the main world exporter, the need to strengthen domestic demand is compelling. Even more so after Donald Trump decided that the US had enough of trade deficits.
Henceforth, it is clear that would be unsavvy to pursue a bold and sudden cut of total debt. Still, ‘precise deleveraging’, i.e. increasing lending in some sectors while encouraging it in others, is not easy to achieve – at least, when you want to maintain a stable outlook at the same time. The target itself, not to increase the total debt to GDP ratio, is arguable: 260 percent is a significantly high figure, and if a recession is a-coming, it should not be a bad idea to decrease it by a notch.
However, this is not the only concern stemming out from Beijing’s liabilities preferences. At the end of the day, we are living in years where national sovereignty is on the rise, at the expense of the good ol’ multilateralism. Why should European observers bother with the debt of some country eight time zones away?
Well, because 78 other countries are involved.
Five years ago Xi Jiping launched a far reaching, overly ambitious project: the Belt and the Road Initiative or, according to his own words, ‘the project of the century’. The aim of the project is to strengthen hard and soft infrastructure in order to build a close network of roughly 80 countries, targeting a wide range of investment projects – from roads and railways to trade agreements and even university exchange programs.
The BRI covers about two thirds of the world population and amounts to circa $1 trillion. It can be seen as the second edge of a Chinese binary strategy: if on one hand Beijing is pursuing the maturity of its domestic market, on the other hand it is preparing to be at the center of the globalized world once it will have become the first economy. A grandiose Marshall Plan, laying out the basis of a new world order and projecting the power and influence of the superpower on charge of it.
Still, if the Chinese ambition is to build an empire where the sun never sets, many shadows are looming over the project. The underlying assumption, that pursuing a Chinese-like growth based on infrastructure and manufacturing will lead to economic success, is short of a fundamental prerequisite: the investment in infrastructure and manufacturing must be high-performing. The majority of BRI’s are not.
Many of the recipients of the program have among the highest country risk level of the world (well above the average for emerging markets). According to Moody’s, the median credit rating of the countries involved is Ba2 – in other words, at junk investment quality.
State-controlled banks and investment funds have been lending to projects that Western investors would never take into consideration, embedding the funds in contracts that do not indulge in environment protection or local workers conditions. Coming back at the domestic debt issue, the Chinese contractors of the Initiative have a median total debt to EBITDA ratio five times higher than the top 10 non-Chinese global contractors. Cosco Shipping Holdings, which bought a controlling stake of the Piraeus Port in 2016, was six times more leveraged than the acquisition target. Now that Beijing pledged to pursue debt sustainability, the centrally-owned investors may redirect their funds to safer, more profitable recipients, leaving under strain the current investees.
Indeed, we have already witnessed some of the damages the BRI can provoke to the Chinese partners. Pakistan, one of the main players in the program, is struggling to avoid an IMF bailout. Its balance of payments has been puzzled by a surge in capital good imports ultimately related to the several Chinese infrastructure investments. Beijing is asked to step in and save Islamabad from its foreign currency shortage crisis with further loans.
The case of Sri Lanka has become exemplary to underline the downfalls of the Initiative. Chinese contractors financed the construction of the port of Hambantota, a project which was dysfunctional from the beginning (the country had already a better connected and more efficient port and no need of a second one). Unable to keep up with the debt repayments, the local government had to hand over the port to the Chinese investors. If this represents a failure in terms of the economic integration the BRI aims to, Beijing can still ascribe it as a win: it has now a stronghold only a few hundred miles away from Indian coasts. Moreover, the Malaysian government has suspended its participation to the program as it is questioning the ‘equality of the treaties’ – and probably realizing that allowing financial inflows worth 40 per cent of the GDP could trouble the balance of payments.
And that’s only the beginning. The Belt and the Road Initiative has a time-horizon of several decades, and it is too early to observe its effects. Still, the first consequences has been unfolding, and they seem rather gloomy. Setting 80 countries up to financial strain risks to become Jiping’s legacy. The other powers stay still, observing with mild curiosity. Washington is retreating from its world leadership role, the EU is still engaged in its internal struggles – Brexit, Euroscepticism, the immigration puzzle, the antagonism from Visegrad. Russia has simply not the weight to replace either of them. China is on the rise, and it is alone. Beijing seems to have a quite simple agenda: to expand. No ideology or social system seems to be pushed forward. And it is pursuing it with the only model it knows, and that has been proven successful so far – leverage. There is only a question to answer: is this growth a healthy perspective or a cancerous threat?
WRITTEN BY SAVERIO SPINELLA FOR BESA
PLEASE DIRECT ANY INQUIRY TO AS.BESA @UNIBOCCONI.IT