Chinese checkers: What exactly is Beijing up to?

China's aggressive behaviour is seen not only with respect to Taiwan or India or the South China Sea but also vis-a-vis Australia/European Union/America

Chinese behaviour, post-Covid pandemic, has been puzzlingly proactive -- to the point of aggressiveness. Earlier, they were better behaved, and Google associated Chinese puzzles with names like Tangrams (which consists of seven flat pieces of triangles/rectangles that could be assembled to not only form a square but a host of human figures, animals and landscapes whose silhouettes were provided in the box) progressing on to the more complex strategy game called Mahjong, which is usually played by 3-4 players.

However, nowadays, aggressive behaviour is seen not only with respect to Taiwan or India or the South China Sea but also vis-a-vis Australia/European Union/America, giving rise to the description ‘Wolf Warriors’ for Chinese diplomats.

Then, within China, public disciplining of some of the largest Chinese e-commerce companies – such as Alibaba, the Chinese ride-sharing leader Didi, New Oriental/Tal Education and a host of other Chinese e-education companies -- keeps getting announced by an otherwise secretive and enigmatic governance system. Basically, companies with successful Wall Street standing seem to be experiencing newly devised regulatory action, even though, post-2008, the primary growth engine, other than realty, has been the tech sector, which not only accounts for almost 40% of the Chinese economy (according to Goldman Sachs) but is also the envy of other countries.

The Chinese dollar bond market is also currently in turmoil. It is the second largest after America’s, though it was opened to foreign investors only a few years back through government-controlled schemes such as Bond Connect Programme and Qualified Foreign Institutional Investor schemes. A good 20% of the market is in non-treasury or non-policy bonds issued by realty companies or local governments.

Also read: Ahead of talks, Army Chief says India will not pull back troops as long as China does not withdraw build-up along LAC

This turmoil started with the ongoing slow-motion unravelling of the property construction giant, the Evergrande Group. Evergrande is China’s second largest property developer, with $355 billion in assets across 1,300 developments. It has 200,000 employees and 3-4 million contract labourers for construction. The company started delaying repayments after the recent promulgation of ‘Three Red Lines’. These specify that the property developer’s ratio of liabilities to assets must always remain below 70%, ratio of net debt to equity always remain below 100%, and ratio of cash to short-term debt always be at least 100 %.

Several other Chinese property companies are reporting similar distress or debt payment delays. Only one of China’s 15 largest property developers is supposed to be fully compliant, setting off global alarm regarding the overseas liabilities of these companies.

Another alarming consequence for global investors has been the resultant collapse in land sales by the local governments. This previously generated almost a third of local government revenue required to help pay principal/interest on several hundred billion of dollar debts raised by thousands of local government financing vehicles (LGVFs).

The oddity is that the Chinese regulatory system had, as early as 2005, perfected their system for obtaining micro-information on economic players through an Aadhaar-type unique identification system for all types of borrowers and exporters and was thus well aware of the borrowers’ indebtedness and the implications of regulatory changes.

Then, there is news coming out that several provinces in China are reporting electricity shortages on account of regulatory cutbacks. Manufacturers and local cities are reporting long-drawn power cuts. China has never reported electricity shortages in the last 20 years but recently publicly committed to peak its CO2 emission by 2030 and attain carbon neutrality by 2060.

Though China has always micro-monitored economic parameters, using the now well-known Li Keqiang index, certain provinces were suddenly (and oddly) found using more electricity than they had committed to. As a correction, provinces were classified into red, yellow and green zones and up to 90% reduction ordered for red zone provinces. Adverse impacts on fertilizer, steel, aluminium, cement, glass and ceramic industries are already being experienced and fears regarding supply disruptions in electronics, component manufacturing and chip availability are being voiced.

This will also disrupt container availability, creating its own separate chain effects on global trade. Adverse side-effects are likely on global inflation, in particular food inflation, perhaps aggravating the fallout of the easy money policies being followed by the EU/US to restore growth in the post-Covid environment.

A possible side-effect could also have been a sudden increase in Chinese demand for a greener fuel, natural gas, exerting pressure elsewhere. It may not be entirely coincidental that the benchmark European gas prices are now equivalent to over $200/barrel oil, creating an interesting prelude to the UN Climate change conference, COP26, scheduled to start in Glasgow, at the end of October.

Perhaps a clue arises from the coincidental fact that post-2008 global financial crisis, China altered its financial model. It increased usage of external borrowings for domestic projects while reducing the size of its cash reserves by venturing into overseas commercial project lending. In 2010, the gross external debt of government/semi government/private companies (in various currencies, including Yuan/RMB) had been $0.5 trillion on a GDP of $6.09 trillion. It now stands at $2.4 Trillion on a GDP of $14.7 trillion. Chinese Forex reserves are currently $3.3 trillion, marginally different from the $2.8 trillion of 2010 (of which, reserves denominated in USD are now only about a third), but its overseas lending (trade plus long-maturity development loans) is now $5.6 trillion versus the earlier $1.6 trillion. In a sense, China has reduced its dependence on the US economy and can afford to play games.

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