Evergrande isn’t China’s Lehman moment

Many in the US establishment must hope that the crisis would put the brakes on China’s growing military might.
Well, it ain’t gonna happen, says T T Ram Mohan, who was appointed a member of the prime minister’s economic advisory committee on Wednesday, October 27, 2021.

It was hard to miss a touch of glee in Western commentary on the possible collapse of China’s real estate company, Evergrande. The Chinese had it coming, didn’t they? China’s growth miracle had been fuelled by debt for quite some time. Now, the Chinese were getting their comeuppance.

Some weeks after its problems surfaced, Evergrande has missed its third round of bond payments. But concerns about a broader financial stress emanating from the firm are on a lower key.

Predicting doom for the Chinese economy isn’t new. Commentators have been telling us for a decade now that China’s debt bubble was about to collapse. Earlier, it was public debt disguised as loans in the State-dominated banking system. Pundits warned us about a looming banking crisis. It didn’t happen. Instead, China’s banks seem to have grown their way out of trouble.

Of late, it has been the build-up of corporate debt, especially in the real estate sector. With housing supply outstripping demand, there was no way the debt accumulated by the sector could be serviced. Defaults and insolvencies in the real estate sector were inevitable.

As the real estate sector is over 25 per cent of China’s gross domestic product, Evergrande’s problems, the pundits said, were bound to transform into a serious crisis for the Chinese economy. Many in the US establishment must hope that such a crisis would put the brakes on China’s growing military might.

Well, it ain’t gonna happen. This isn’t quite China’s Lehman moment, a dramatic firm failure with implications for the world economy.

A crisis in the real estate sector or in the stock market need not translate into an economy-wide crisis. What’s material is the condition of banks. A crisis in the real estate sector or the stock market has systemic implications only if it leads on to a banking crisis triggered by multiple bank failures.

In the global financial crisis of 2007, fundamental macroeconomic imbalances were at work. But the magnitude of the crisis arose from the disastrous decision to let Lehman Brothers fail. A similar outcome is unlikely with Evergrande because, first, China’s banking system is in good shape today and, secondly, the authorities will do what it takes to limit the contagion effects of a real estate crisis.

China’s banking numbers look better than those of many other banking systems. In June 2021, the ratio of non-performing loans to total loans was 1.8 per cent, a pretty impressive figure in Covid times.

Return on assets was 0.83 per cent and return on equity 10.4 per cent, again acceptable numbers in the present situation. Going by the official figure for the provision coverage ratio (PCR), 193 per cent, returns in Chinese banking are hopelessly understated.

The PCR in Chinese banking has been at this level for several years now. It suggests that Chinese banks have taken seriously Western commentators’ forecasts of a credit crash and provided aggressively for the reckoning!

China also has the fiscal space today to bail out firms if required. China’s public debt-to-GDP ratio of around 70 per cent is modest by the level of public debt consequent to the pandemic.

The authorities will do whatever is required to ensure that real estate failures do not destabilise the banking sector or the economy at large. They will choose the firms that will be allowed to fail. They will arrange for restructuring of liabilities and infusion of capital into firms that they believe should survive.

This is, perhaps, what the president of the Asian Development Bank meant when he said that China has sufficient buffers and policy tools to prevent the Evergrande group from triggering a global crisis. The International Monetary Fund reiterated this view earlier.

The convulsions we are seeing in the Chinese economy are largely unfolding in accordance with the script of the Chinese leadership. They have concluded that runaway growth in the real estate sector, fuelled by debt, is unhealthy. They are attempting a reorientation of the economy with a smaller role for the real estate sector.

Similarly, fintech firms are being reined in because the Chinese Communist party wants a better grip on the Net, including social media. The crackdown on edtech firms is happening as part of an attempt to level the playing field in education.

If the cumulative impact of these and other measures is to cause the economy to slow down, the leadership seems willing to live with it.

China is unlikely to sustain growth at 7-8 per cent in the years to come. But growth of 5-6 per cent seems feasible. And even at that rate of growth, the world’s second largest economy will remain a force to reckon with.

Turbulence at the IMF

The managing director of the IMF, Kristalina Goergieva, has managed to keep her job. The storm that erupted over allegations that Georgieva pressured her subordinates to tinker with data when she was CEO at the World Bank has passed. The tinkering was said to be intended to boost China’s rank in the World Bank’s Doing Business report.

The IMF’s executive board has concluded that there is no conclusive evidence of misconduct on the part of Ms Georgieva. However, US Treasury Secretary Janet Yellen, a former pal of Ms Georgieva’s, has served notice that the IMF chief’s actions would be closely watched.

Those who believe that the IMF and the World Bank are useful institutions to have, despite their failings, will heave a sigh of relief. The IMF has not been lucky with its heads in recent times.

A French court found Georgieva’s predecessor, Christine Lagarde, guilty of negligence in approving a payout of taxpayers’ money to a businessman. The court, however, let Lagarde off without any punishment.

Lagarde had succeeded Dominique Strauss-Kahn who resigned following allegations of sexual assault. Yet another MD, Rodrigo Rato, was guilty of embezzlement, albeit long after he had left the IMF.

The top job of the IMF is the preserve of Europeans just as the US has a monopoly over the post of president of the World Bank. Some would argue that the experience with recent European chiefs should prompt the board of the IMF to cast the net wider in filling the post of IMF chief. Cynics will say the problem is not nationality; in the higher reaches of finance, one cannot expect an excess of scruple.

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