Conjectures about the Evergrande case

Jan Martel (1896–1966), Maquette for Arbre Cubiste (Cubist Tree), 1925.
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By PAULO NOGUEIRA BATISTA JR.*

Zero chance that China will decide to allow the company to collapse

Conjectures? The perplexed reader might ask. The bewilderment would be understandable. Economists like to present themselves as faithful to the facts and, even more, to the hard facts. Ah, reader, but one of the best kept secrets of our profession is that we almost never, not to say never, have access to hard facts.

It may even be doubted whether there is anything that can be presented as "facts", without quotation marks. The fact is that “there are no facts, only interpretations”, as Nietzsche said. In general, but particularly in the field of economics. All our facts, especially the soft facts, are contaminated by perspectives, values, conjectures. Without wanting to complicate things unnecessarily, the only fact is that there are no facts – and even that fact can be questioned. And the economist, in particular, is always talking about topics that he doesn't truly master.

Well, that's just a simple introduction. My topic today is China and, within it, the rumored Evergrande affair. Now, for China it is worth a fortiori what was said in the first paragraphs. For at least two reasons. The first is that the Chinese have no respect for transparency. They worship, on the contrary, the most radical opacity. The second reason is that everything said and read about China in the West is hopelessly affected by deep-seated fears. Westerners, especially Americans, fear, on the one hand, China's geopolitical competition. As a result, there has long been, since the 1990s at least, a fierce fan base against China. I've lost count of how many times Western economists and organizations have predicted the collapse of the Chinese economy. So far, all the negative predictions have turned out to be wrong. And the Chinese continued, undaunted, their economic rise in the world.

But there is another reason for cheering against China. It's just that Americans don't want to have to explain to their diverse audiences at home and abroad how it is possible that an economic system so different from Western capitalism can be so successful in the long run, leaving the developed economies on both sides of the North Atlantic in the dust. and also Japan. How to explain that a deeply state-owned and state-controlled economy – which calls itself “market socialist” – can display a persistent dynamism, invariably defying the pessimism of its critics and traditional economic doctrines? Here is a theme for an essay of at least 800 pages, which a Westerner would hardly be able to write.

Finally, I come to the subject of this article: the financial problems of the giant developer Evergrande. And having made all the above reservations, I beg you to present my modest conjectures.

It does not seem to me, first of all, that the Evergande case can be considered a “Lehman moment”, as has been repeatedly said in the western media. That is, it will not be an event capable of triggering a systemic crisis in the Chinese economy and in the international economy. To start the conversation, it is worth remembering that the collapse of the Lehman investment bank, in 2008, was an outlier in terms of Western practices. US monetary and fiscal authorities were foolish enough to let a major financial institution fail, triggering a run on other institutions on both sides of the North Atlantic. They decided to give a “moral lesson” to a particularly irresponsible financial entity, but were forced to beat a quick retreat in the face of the systemic financial crisis that took shape.

I do not believe that Evergrande will collapse, in the sense of defaults followed by bankruptcy. The Chinese state is not watching the company's drama with its arms crossed. It is the second largest real estate developer in an economy that depends especially on real estate construction and infrastructure investments. Construction accounts for a significant part of gross fixed capital formation.

Zero chance that the State will decide to allow a collapse to teach a moral lesson. Is there, then, a “moral hazard”? In other words, to avoid systemic risk would China be willing to set a bad example by bailing out irresponsible businessmen? This reasoning, reader, seems to me an example of the undue application of the western way of thinking to the completely different reality of China. The company and its works will be “saved”, in some way, and it seems likely that the State will be responsible for honoring most of its obligations, at least the internal ones that are the largest part of the liabilities. But business owners, shareholders and executives will be held accountable, likely with a severity unusual in the West. What sense does it make to speak of “moral hazard”?

Evidently, intervention will not be easy for China. Evergrande is a large company and there will be a significant fiscal cost in the absorption of its obligations by the State or by public companies. Part of these obligations, internal bank debts, are already indirectly liabilities to the State, since almost all of the Chinese financial system is state-owned. However, China can afford these costs. The Chinese state has what Americans call “deep pockets” and can afford the loss – all the more so as it is mainly internal, given that the company's debts are predominantly in yuan.

More worrying for China is the adverse effect the Evergrande crisis will have on the growth rate of the country's economy. After a rapid recovery in the first half, GDP growth projections were already being downgraded due to the new outbreak of COVID-19 associated with the delta variant. There should now be further slowdown in growth. This is due not only to the size of Evergrande and the aforementioned importance of real estate construction for the country's economy, but also to the increase in doubts and uncertainties. Is Evergrande an isolated case? Or are there more companies struggling in the industry?

For the rest of the world, the main channel of contagion appears to be commercial, as Evergrande's external debts are relatively small. China is the biggest trading partner for most, if not most, countries. Thus, Brazil, for example, suffers not only because China is the main market for its exports, but also because a Chinese slowdown harms other countries that are important customers for the country. As China is the largest economy on the planet (by purchasing power parity), the retraction in its growth rate will affect the growth of the rest of the world economy.

*Paulo Nogueira Batista Jr. he holds the Celso Furtado Chair at the College of High Studies at UFRJ. He was vice-president of the New Development Bank, established by the BRICS in Shanghai. Author, among other books, of Brazil doesn't fit in anyone's backyard: backstage of the life of a Brazilian economist in the IMF and the BRICS and other texts on nationalism and our mongrel complex (LeYa).

Extended version of article published in the journal Capital letter in 01 October 2021.

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