China’s Financial Woes

Ichiro Suzuki

As competition against the U.S. intensifies, President Xi Jinping is aggressively seeking diplomatic relationship with countries in the developing world, or the Global South, in an attempt to keep the distance from the world ruled by the West. Developing countries essentially find the lure of China in financial largesse that Beijing splurges so generously. Even prior to Xi’s rise to the helm, China aggressively courted these countries, often those under not so democratic regimes. China money appealed especially to autocratic rulers, in the absence of stringent conditions attached to them, unlike those by the World Bank. At least such conditions are not brought to light much later. China has been willing to finance projects that the World Bank might not, put differently projects with questionable return prospects. Such projects lured autocratic rulers since they take so much pride in white elephants that showcase their achievements. (In democracy, too, politicians want to show off roads and bridges as their accomplishments. Japan was notorious on this until recently.)

Aggressive lending accelerated under President Xi, in Belt & Road Initiatives (BRI). Building infrastructure in the Global South is a worthy goal, since such projects were sourly needed to enhance productivity and hence growth. Some of the BRI projects did have the same effects as high ways, bridges and roads built in China under Deng Xiaopimg and in early years that followed his death in 1997. Mombasa-Nairobi standard gauge railway was a case in point. So is Adis Abeba - Djibouti railway. Both of them connect an inland capital city with a major port, giving rise to an immense productivity boost.

On the other hand, many of the projects are unlike those railways. More often than not, projects are not well thought out, escaping financial scrutiny. Some of them only fill up egos of an autocratic ruler. When the borrowers begin to struggle in repayment, conditions that looked non-existent at the outset begin to emerge. Such hidden conditions could be onerous as Sri Lanka had learned the hard way already a few years ago. Though such conditions bind the borrowers allowing Beijing to recoup returns from a broader perspective, their struggle is a big negative for the lenders, too. The Chinese government might seize the assets, as perhaps surreptitiously stipulated in the contract, but banks, even if state lenders like the Development or the Export-Import Bank Bank, still don’t get repaid by the borrowers anyway, weighing on the system as a whole. Woes of the borrowers, and also of the lenders, can only grow amid the Fed’s aggressive move to contain inflation that is running at 40-year high. While China might be lending in the renminbi that has seen no rake hikes so far, the bulk of the Global South’s borrowings from non-Chinese lenders is in U.S. dollars. “When the Fed tightens, bad things happen” says an old Wall Street axiom. Higher rates hit the weakest link in the global economy. Most of the BRI clients have not been known for their prowess to manage their finances, and there are some serial defaulters, i.e. Pakistan, Beijing’s major client state.

On the domestic front, China’s banks are facing no better environment. Over-dependence on real estate development and infrastructure projects are already well documented. Strained balance sheets and cashflow problems of some ultra aggressive developers is a public knowledge. As over-leveraged developers are no longer able to continue on their housing projects that have already been sold, a growing number of borrowers are refusing to service their debt. Authorities are pushing banks to keep lending to viable developers so they can complete the halted projects. That sounds like a good social policy but keeps the lenders tied to the strained developers who may or may not be around in the not so distant future. Even outside of the most abysmal players, real estate development has already ceased to be a license to make money while ago.

In the first decade of the 21st century, rise of Chinese banks seemed unstoppable. The Chinese economy was at one point growing at 20% annually in U.S. dollar terms, nominally (including inflation). 15 years ago, some thought they were on the verge of taking over the world, with Chinese institutions crowding the list of the world’s largest banks. Today, they are shadows of former selves, facing clear limits on growth and being afflicted with deterioration of financial health. Their share prices, already a fraction of what they once were worth, still keep rewriting multi-year lows.

About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.