China at the Multiple Crossroads

In this age of financial geopolitics, the essential thing for global financial institutions is to learn to take "national security into account at ev

Cover Image Attribute: Traffic on an elevated intersection in downtown Shanghai | Source: Johannes Eisele / AFP via Getty Images

According to a research report released Wednesday by the Institute of International Finance (IIF), foreign investors continued to reduce their holdings of Chinese bonds in July. In addition, they liquidated their equity holdings for the first time in four months. As a result, IIF estimates that $3 billion in Chinese debt was sold off last month, while $6 billion was taken out of other emerging markets.

The risk of a global recession, inflation, and a strong dollar all contributed to a flight of capital from emerging markets. As a result, this streak of five consecutive months of portfolio outflows sets a new record since 2005.

Image Attribute: Health workers wear protective suits while waiting to register office workers for COVID-19 tests in Beijing on April 27, 2022 | Source: Kevin Frayer / Getty Images  

As local COVID-19 flare-ups, partly due to Beijing's zero-COVID policy, the debt bomb is ticking louder, resulting in a decline of 7 percent for the benchmark CSI 300 Index. This decline occurred every week in July. According to the data released last month, China reported an increase in the country's gross domestic product (GDP) of 0.4 percent for the second quarter, which fell short of the 1 percent that many analysts projected via a Reuters poll. It was the worst report since the nation reported a contraction of 6.8 percent in the first quarter of 2020 as it began fighting the virus. 

Image Attribute: House Speaker Nancy Pelosi, left, and Taiwanese President Tsai Ing-wen meet in Taipei on Wednesday. | Source: Taiwan Presidential Office

Additionally, House Speaker Nancy Pelosi has recently visited Taiwan as part of her tour of Asia. She is the highest-ranking official from the United States to visit the island nation in the past quarter of a century. This has escalated tensions between the United States and China, the latter of which considers Taiwan, a self-governing democracy, to be a part of China.

On the other hand, China's real estate market burdened by debt stands out as the most alarming red flag. The country's most prominent real estate developer, China Evergrande Group. The company has borrowed more than $300 billion to finance its operations and has already defaulted on its debts. There is a good chance that there will be more defaults because Chinese developers are liable for $13 billion in dollar-denominated bond payments in the second half of this year.

Image Attribute: The cash-strapped property developer, China Evergrande Group's headquarters in Shenzhen, descended into chaos on September 13, 2021 | Source: South China Morning Post 

Even China's heavily indebted municipalities face bleak futures. Local governments are estimated to face a shortfall of 900 billion yuan ($6 trillion) this year due to declining land sales revenue and decreased tax receipts due to the current real estate crisis. As a result, it will be difficult for local governments to pay back their debts which they have acquired by borrowing extensively from banks or issued bonds.

Major financial institutions based in China are also experiencing difficulties. As part of the expansive Belt and Road Initiative being undertaken by China, they have extended loans in the tens of billions of dollars to less developed nations. However, due to the global economy's slowdown, their borrowers cannot pay the debt they have incurred, which means that a sizeable amount of their credit portfolio is likely to become nonperforming.

All these developments (both domestic and international) could have significant economic and national security implications for China in the coming months. In this age of financial geopolitics, the essential thing for global financial institutions is to learn to take "national security into account at every turn."

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