Search
  • Bocconi Student Boutique Banks

The Economic Recovery Post-Covid: A Chinese Case Study


 



Introduction


On the night of the 15th of November, the US president Joe Biden met his Chinese counterpart Xi Jinping for a virtual meeting. This discussion brought light on one fact: the global economy is struggling. Many of the most important economies on earth are facing problems related to the consequences of the pandemic, even China, the second-largest economy on earth. Thus, the presidents tried to agree on a healthy competition between the two major powers.


In this article, we will focus on the Chinese economy, which is growing at the slowest pace in a year due to a massive energy crunch, shipping disruptions, and a deepening property crisis.

 

The Chinese Economy Slowdown


China’s V-shaped economic rebound is fading faster than expected, catching analysts off-guard and posing a new headwind for the already uneven global recovery.

That is the emerging consensus as falling property prices, nervous consumers and a cooling manufacturing sector all point towards slowing momentum in the world’s No. 2 economy. A surprisingly restrained policy response from Beijing has dampened hopes for more support, at least for now. To put the turnaround in context, only a few months ago economists had banked on China cruising past an 8% growth rate for 2021 and carrying strong momentum into 2022. While this year’s expansion may yet hit the forecast range, the slowdown means Goldman Sachs Group Inc. and others warn China could see sub-5% growth next year.

For the world economy, the development threatens to strip away a key ballast of support. China’s hunger for raw materials and its quick reopening after the initial pandemic wave helped to fuel the global rebound too. An energy crunch over September and October coupled with elevated cost pressures is squeezing corporate profits and hitting factory output. In this context, economists expect China’s industrial production to expand at the slowest pace since early 2020, at 3%.


Falling real-estate prices and credit-market turmoil for heavily indebted developers means fixed asset investment in the first 10 months of the year is expected to have slowed to 6.2%, compared with the previous 7.3%. Economists warn that the downturn in real estate - which accounts for up to 25% of output - could hurt the wider recovery. Falling real-estate prices are a major consequence of the drastic financial situation of Evergrande. The story of the world's most indebted developer teetering on the brink of collapse, and the potential for it to trigger economic pain globally, has captured headlines around the world.


On Wednesday, the cash-strapped developer once again averted a disaster with a last-minute bond payment. This time, customers of international clearing firm Clearstream received overdue interest payments on three-dollar bonds issued by Evergrande.

It's the third time in the past month the company has paid up dangerously close to a deadline. The bonds had a total of more than $US148 million ($A203 million) due. But the cash-strapped developer still has about $US 300 billion ($A 412 billion) in liabilities. Thus, if Evergrande fails, it could trigger the collapse of the Chinese property market, which would cripple China's economy. China is Australia's biggest trading partner, which means the local economy could suffer, too. Iron ore prices have already taken a hit as construction in China slowed down.

 

Where Is The Money Coming From?


Weiping He, a researcher in financial markets regulation and company law from Monash University, said it was likely that the Chinese government was working behind the scenes to help Evergrande meet the payment deadlines. "Local financial institutions could be helping, and that is the hand of the government at work," she said. She added that "Local companies, which are state-owned or otherwise privately owned companies would also be encouraged by the government to come in to assist individual housing projects or subsidiaries to ensure that housing projects are delivered."

Reuters has reported that the Chinese Communist Party (CCP) has been telling government owned firms and state-backed property developers such as China Vanke to buy some of Evergrande's assets.

The CCP is also said to be unlikely to directly intervene in the form of a bailout. A handful of government-owned enterprises have already done due diligence on assets in the southern Chinese city Guangzhou, according to Reuters. Guangzhou City Construction Investment Group is said to be close to acquiring Evergrande's Guangzhou FC Soccer stadium and surrounding residential projects. The stadium is believed to be worth around 12 billion yuan ($A 2.6 billion) and has been designed to seat more than 100,000 — making it the world's largest venue built for soccer by capacity.


Overseas media have also reported that Evergrande's billionaire founder and chairman Xu Jiayin could be forced to pay some of the debt from his personal wealth. Some outlets have reported that Evergrande have sold off private jets and that a mansion has been used as collateral to secure bank loans. Xu is worth an estimated $7.2 billion ($A 9.89 billion), according to Bloomberg's Billionaire Index. But with the company's liabilities around 40 times that, Xu alone could not save Evergrande.

 

What's Next For Evergrade?


Evergrande's future will hang in the balance for some time yet. Dr. He does not believe Evergrande would formally default, with the most likely outcome being a gradual restructure.

"It will still survive. Evergrande's Investors and creditors are probably last on the government's priority list," she said. "The government cares about the people who have paid lots of money to buy residential apartments from the company to live in. That's the aim of the government. It is a stability issue." Evergrande's next payment deadline is on December 28, when it's due to cough up more than $255 million in coupon payments.

 

The Government's Rule Of Law


For many years, the Chinese economy has been relying on real estate as a driver of economic growth. In fact, real estate activities represent more than a quarter of Chinese GDP. Moreover, the Chinese housing market is among the most expensive worldwide; to put it in perspective, it would take 25 years of savings to buy a house in Shenzhen, 13 years in London, and 9 years in New York.


To contrast a potential housing bubble and regulate one of the most important sectors in the state’s economy, the government ruled out the so-called “three red lines” rule for real estate companies. Developers who want to refinance are being assessed against three conditions:


i. Liability to asset ratio (excluding advance receipts): a 70% ceiling on liabilities to

assets, excluding advance proceeds from projects sold on contract.


ii. Net debt to equity ratio: a 100% cap on net debt to equity.


iii. Cash to short term debt ratio: cash to short-term borrowing ratio of at least one.

This ruling was the main reason for Evergrande’s crash.

By respecting all these conditions, developers can increase their debt by a maximum of 15% in one year. Otherwise, developers with a weak balance sheet may need to cut home prices to boost sales and shore up cash. This was evident in Evergrande’s campaign last year to offer discounts of as much as 30%.

 

Aims For The Future


The Evergrande crisis represented a significant issue for the Chinese government, and it could mean a turning point for the Chinese economy. Moreover, many analysts claim it anticipates the end of the Chinese “real estate boom,” and the “build, build, build” economic model. The government recently promoted a shift towards technology, green technology, and other sustainable models.



China’s tech power has grown remarkably, with its digital economy accounting for about 30% of its GDP (2X since 2008); PWC predicts that AI technology could contribute a 26% boost to GDP by 2030. Furthermore, the Chinese government aims to become the global technological superpower by 2050. China now holds 75% of AI patent applications, 50% of global digital payments, and 75% of the global online lending market. As for the latter, the government aims to make Chinese society a cashless society - Fintech investments increased by +252% from 2010 to 2016. By that time, the value of China’s mobile payments totaled $790 Billion (11X compared to the United States).

Another important goal set by the Chinese government is energy transition towards carbon neutrality. In particular, the Asian country proposed to hit peak emissions before 2030 and realized carbon neutrality by 2060.

As of now, China is among the biggest producers of wind and solar power worldwide. Moreover, battery electric vehicles consumption is surging at an impressive rate - in 2021, 10% of auto sales in China were electric vehicles.

However, nowadays, China is still the world’s biggest polluter in terms of total yearly emissions (it is responsible for 23.92% of the world’s annual emissions) and the third in terms of tonnes of CO2 per capita. In fact, the Asian major economy relies on fossil fuels for about two-thirds of its electricity production.


Written By: Alessandro Bollati, Ali Chaer



A Chinese Case study - BSBB article
.pdf
Download PDF • 516KB

79 views

Recent Posts

See All