In the first part of this article we described how China is piling up a debt that has reached 350 percent of its GDP. The borrowing spree, starting with the international financial crisis of 2008, had initially a laudable goal. The massive 4 trillion Yuan was to be used to give a stimulus to the economy to avoid the contraction that many countries suffered during that crisis. Yet, high life on borrowed money is addictive and difficult to roll back and China has not looked back since then. Being a closed society, that nation’s stimulus spending is not subject to transparent audit and this acts as an incentive to the greedyparty officials. The problem is even more severe at the sub-national level. Local governments are praised for undertaking showcase projects irrespective of the utility and revenue outcomes. As early as 2014, the problem was highlighted in the Financial Times about “hyperactive construction that has generated $6.8 trillion in wasted investment since 2009”, that is just in five years. It described how “ghost cities” of empty apartment blocks, abandoned highways and dysfunctional steel mills were found all over China. It was estimated that during these five years, officials stole 5 percent of national GDP every year through such projects.
Dushan County in Guizhou province,a very poor region, is a good example of this reckless financial behaviour. Exposure of official profligacy is rare in China and can result in serious difficulties for the person undertaking this misadventure. Yet, a video report “How Dushan burnt 40 billion” has gone viral on Weibo, China’s clone of Twitter. The poor county, with less than 400,000 inhabitants,launched construction frenzy with borrowed money in 2017. Among the projects was a 329 ft. high building, made entirely of wood, raised in the hope of getting a place in the Guinness Book of Records. The structure, costing more than $28 million, turned out to be of no use and has been abandoned.The county has an annual revenue of just 1 billion Yuan and has piled up debt of 40 billion Yuan. Investigations revealed that the motive behind such imprudence was greed of the local officials. The problem is known to be widespread in India too where corrupt officials are too keen to undertake expensive construction projects as these represent a potential for large illegal income. In China, however, only such corrupt officials face the brunt of law as fall foul of the party apparatus.
Dushan County is not an exception but the rule. The Wall Street Journal in its May 2020 report “China’s local governments binge on off-the-books debt” described how, in response to the Covid19 crisis, local entities with no answerability were issuing bonds to finance projects that may not generate enough income to service these bonds. These 3.75 trillion Yuan local government bonds cameeven asthe budget deficit increasedfrom 2.8 percent to 3.6 percent due to fiscal incentives as relief measures. This tax cut lowered state revenue,further eroding the capacity to repay borrowed money. The additional bonds and responses to the economic effects of the pandemic represent 5.4 percent of the GDP. As a result, debt default by government entities has soared to 30 percent while default by local governments reached 50 percent. It is not stopping the local governments from lapping up the opportunity presented by the Covid19 crisis. The city of Guangzhou alone has announced projects for 500 billion Yuan. As an indicator of one-upmanship, the Guangdong province, of which Guangzhou is a part, announced investments of 5.9 trillion Yuan.
The obvious question that arises from this situation is: Why do China’s and the world’s investors keep pouring money into China’s bonds? Dinny McMahon in his book, “China’s Great Wall of Debt” published in 2018,revealsthe secret: “By fraudulently inflating their earnings, these companies could sell shares for much more than they were actually worth, allowing the Chinese owners to fleece American investors, who blindly overpaid.” In a closed society, complex problems have simple solutions! In the free world, companies and governments have reliable credit ratings to guide investors about the safety and earning potential of their investment, triple-A being the preserve of the strongest, like Microsoft and Johnson & Johnson. In totalitarian China, the most common rating given to companies seeking investment is triple-A, being enjoyed by 57 percent of the onshore companies. The Wall Street Journal, in an article (“In China, not all triple-A-rated bonds are created equal”) on October 22, 2020, hit hard at this false rating system which dupes the world’s investors into pouring money into China’s bottomless debt pit. During the pandemic, while companiesworldwide suffered falling revenues and consequentratings downgrade, Chinese companies were not affected and some were even upgraded. Take the example of China’s most indebted property developer, the Evergrande Group, whose shares and bonds were plunging and which was given B+ by S&P but it enjoyed A+ in China.
The world was recently given a taste of the dangers of taking decisions for investment in a totalitarian state. Jack Ma, the richest man in China, had announced the world’s biggest IPO, at $37 billion for his Ant Group due to open on November 6, 2020. It was widely believed that it would be oversubscribed quickly and would open at a much higher level in the market. On November 4, middle-level bureaucrats from the state financial regulator met Jack Ma to inform him that he was no more a blue-eyed boy of the Party. Then, the Shanghai stock exchange called to say that the IPO has been suspended indefinitely. Alibaba, which owns a third of the Ant Group saw its shares tumble by $76 billion in a day due to these developments, the loss being more than double the size of this IPO. Jack Ma had criticized these regulators in his remarks at a financial forum in Shanghai a few days earlier and they decided to take him on. On November4, Xinhua, the official mouthpiece of China, virtually confirmed this link. It mocked Jack Ma without naming him but made it obvious by showing the sketch of a horse, the Chinese character for which is ‘Ma’ and wrote, “Words can’t be spoken carelessly, things can’t be done by following one’s heart, nor can people act according to their free will.” What does China’s debt mountain portend for the rest of the world, apart from the obvious ruin of imprudent investors? We must remember that the 2008 financial crisis was triggered by the sub-prime mortgage crisis in the US when the housing bubble burst. Any catastrophe in a leading economy of the world has its disastrous consequences for everyone. The size of China’s economy in PPP terms has been fast approaching that of the US. If some day the Chinese debt volcano blows up, most of the other countries will have their economy smothered in its ashes.
Source : Daily World