I wonder if policymakers at the Chinese Communist Party have been musing on the internal contradictions of capital accumulation as the crisis enveloping China Evergrande Group (HKG: 3333) comes into stark relief?
Marxist theory warns of the inevitability of frothy credit markets and cascading systemic defaults, yet China has pulled millions of its citizens out of poverty by adopting capitalist economic policies, albeit with limited social reforms. You’re apparently free to make money; but that may be the extent of your liberty.
Yet in recent months the Chinese state has been cracking down on various segments of the economy, specifically the national security and digital technology industries, together with state and private monopolies. Beijing has unveiled a new five-year plan outlining a tighter regulatory framework, as it seeks to limit the growing power of the corporate sphere.
The private sector has always wielded significant political power in western economies, and it has probably intensified in the age of social media. China’s reversion to a statist model comes at a time of unprecedented government intervention in the west, so investors will need to review their portfolios as centralised control seems to have become the order of the day.
Share prices for a host of China’s tech stocks have pulled back since the middle of the year, triggered in part by a $2.8bn (£2.04bn) fine that was slapped on Alibaba (HKG: 9988) by Chinese regulators for market abuse, but also by a range of strictures on other Chinese firms that followed.
Markets will now be looking for a steer from Beijing on how it intends to deal with Evergrande and its debt mountain. At its core, the Shenzhen-based enterprise is a large-scale housebuilder with over 1,000 projects spread across mainland China and its territories.
Unfortunately, like any property developer, the group must commit large amounts of capital before it generates any returns, but somewhere along the line management seems to have taken the decision to turn it into a conglomerate by making sizeable investments in an internet company, electric vehicles, a mineral water producer, a theme park, and even a soccer club - Guangzhou F.C.
The group spent like a drunken sailor on shore leave, but the aggressive borrowing was one thing; quite another the alleged practice of overbidding for its land bank assets, effectively transferring the risk to its creditors and the buyers of its properties (sound familiar?).
The first signs that things were coming unstuck came through last year when liquidity constraints were introduced in China, but the world was more preoccupied with Covid-19. At one point the group was forced to tap its own employees, coerce really, as they were asked to provide short-term loans to the group to safeguard their full-year bonuses. Press reports have also emerged that it has started to heavily discount its properties; a sign that it may be struggling to meet its weighty bond commitments.
After the recent crackdown, Xi Jinping is now in a bind. The group's debt issues pose a systematic risk to the Chinese economy and beyond. But if the state intervenes, it will give tacit approval to the actions of senior management at a time when the government is seeking to root-out financial excess.
Given the massive scale of the debt, $300bn and counting, it also represents a huge problem for the nation’s banks. More poignantly, however, there are thousands of buyers who have forked-out deposits for homes which may never be built. At the time of writing, it is difficult to gauge what path Beijing will follow, but people have had to endure stints in re-education camps for less.
Another consideration is that although Evergrande is the second largest property developer in China, it isn’t the only one in hock to the banks. A sustained retraction in property prices could give way to a secondary wave of defaults.
UK investors aren’t immune to this latest contagion from China. Specialist regional investment trusts and funds are obviously at risk, while commodity prices have already suffered as aggregate industrial demand in China has tailed off. Indeed, if conditions deteriorate further in China, it could precipitate a rush into the US dollar which also has negative implications for commodity prices.
A point worth considering is that China’s febrile property market is partly due to an absence of alternative 'paper' investments, with the resultant property speculation a consequence of slow progress in opening China’s financial sector to foreign companies, a process entirely within the purview of President Xi.
Supported by Mark Robinson
