Hu Fulin, the chief executive of a large Chinese eyeglass manufacturer, disappeared a month ago. He is just one of 10 Chinese CEOs to vanish recently, leaving behind a long trail of debt. Hu departed owing $300 million, half of that borrowed privately.
The private market, from underground loan sharks to kin, business barons and the street, has basically replaced China’s tightfisted banks. According to estimates in China, this market turns over 4 trillion yuan ($600 billion) a year. At as much as 70% a year, interest rates in this “alternative market” are much higher than at banks.
Property builders, mainly the small ones, have also borrowed under the radar. A Chinese banker recently told CNBC that one builder borrowed tens of millions of dollars at 60% a year, hoping to repay in a few weeks.
Now, China has about 50,000 construction companies, mostly small and privately owned. Big public companies are less than 10% of the market. Not much is known about the minnows’ activities or how much credit they take out. But why would they resort to expensive underground loans? Mainly because Chinese banks won’t lend to them.
That in turn stems from government policy intended to cool the real estate market. Developers bought land at sky-high prices and their sales have been shrinking. Their dropping income from selling homes forces them to seek funding to complete projects, and they wind up with the loan sharks.
Beijing fears that this process portends the popping of a real estate bubble, as companies that borrowed on the black market dump land at a loss to repay the loans. If this persists, Chinese property values could collapse.
That in turn would slam into the black lending market and all the other ills of an exploding property bubble.
Is China ready? Is the world ready for a crisis in China that would badly hamper growth? Almost certainly not.
China is the anchor of the four-nation speed-growers called the BRICs: Brazil, Russia, India and China. The sobriquet was coined 10 years ago by a Goldman Sachs asset manager, Jim O’Neill. Back then, the four had 3 billion inhabitants, or around half the world’s population. But their share of global gross domestic product was 8%. China’s was 3.6%.
O’Neill predicted that the BRICs would close the gap fast, and he was right, for the most part. China has averaged 10% economic growth over the past 10 years, becoming the world’s second-biggest economy after the United States (which comprises 8% of the global economy).
The other BRIC nations also have grown briskly. The four are now responsible for a quarter of global growth. In India, the pace of families rising to the middle class has grown fourfold. In Brazil, 40 million people have risen from poverty and bought a car or television. Moscow has some of the most expensive housing in the world.
The BRIC nations also skipped over the 2008 financial crisis. Their banks were practically untouched. Their ability to sustain growth during the past three years has helped shield the global economy from the worst of the real estate crises in America and Europe.
But what was true three years ago may not be true today. The economies of the United States and Europe are still struggling with sovereign debt and seem likely to recede into further recession. Hopes that dynamic developing markets will continue to provide demand that will keep the West above water may prove false.
The emerging market economies aren’t where they were in 2007 and 2008. They are in no condition to take more blows, warned Robert Zoellick, president of the World Bank, at a recent International Monetary Fund conference. Their balance sheets aren’t that strong now, he said, and some have had to raise interest rates to fight inflation.
Rising food prices are worrying them too. A drop in developing-world demand, however, imperils the recovery of the entire global economy, Zoellick added.
Yes, the BRICs, the great white hope for global growth, have terrible problems. India and Russia are riddled with corruption. Brazil’s education system is poor and China seems over-reliant on growth driven by property and credit. Any of these could slow the ride.
Russia: rotten to the core
Russia is the outsider of the four: Its population is shrinking, not growing, for one thing. But demography is secondary. The main problem is a governance culture that encourages graft. The communist era was rife with it and two decades later, two distinct classes have emerged: the super-rich oligarchs and everybody else.
Here’s an example. In 2002 a band of Chechen rebels attacked Moscow’s Dubrovka Theater, taking hundreds hostage. About 330 people were killed in the Russian army’s abortive attempt to storm the theater. It turned out that the guerrillas had overcome obstacles simply, even though they were driving cars loaded with explosives and guns. They bribed the guards at the inspection points.
Corruption touches almost all areas of Russian life, from bribing cops to avoid a traffic ticket, to fixing giant government tenders. The chief military prosecutor recently said in an interview that a fifth of the national military budget gets looted, including through cooked books. President Dmitry Medvedev reported that $35 billion had been stolen from government funds in 2010.
According to the NGO Transparency International, Russia is the most corrupt developed nation. It ranked 154th out of the 178 countries the NGO surveyed: One of every four Russians has paid a bribe to a service vendor at least once.
Russian red tape is legion and the government has a hand in just about every sector. Under Vladimir Putin, the number of officials has doubled to a million but service hasn’t improved. “Russia has 140 million hardworking people and 1 million people who want to steal from them,” William Browder, CEO of asset management firm Hermitage, told Time Magazine.
Two years ago, furniture giant IKEA suspended investment in Russia, blaming the bureaucracy and bribes it had to pay. That’s after the company had sunk $10 billion into Russia over 10 years. A year later IKEA fired two managers who had apparently paid bribes − to make sure the stores got electricity. Other foreign firms accused of corruption were heavily fined.
Another problem for Russia is dependence on commodity prices, mainly oil and gas. It’s the world’s biggest oil producer, responsible for 11% of global oil output. Oil rising from $20 to $100 a barrel in a decade did wonders for its trade balance. From bankruptcy, Russia built up foreign currency reserves of $500 billion.
But oil can drop, too. Russian Finance Minister Anton Siluanov recently said that each $1 change in oil prices adds or subtracts 55 billion rubles, or $1.7 billion, from Russia’s kitty.
Also, unlike other developed economies, Russia hardly encourages its industry. Its economy is less advanced, as is its agriculture. Russian companies are not early technology adapters and the economy is uncompetitive, for the most part. Income gaps are growing.
India: Bad infrastructure
Like the other developing economies, India’s middle class has blossomed − but 10 million Indians sank below the poverty line in the second half of 2010 because of surging food prices.
India’s economy is growing fast, yet the country remains poverty-stricken. Some 32% of its 1.2 billion people live below the poverty line. Indians spend half their income on food so any increase affects them immediately.
And prices have been rising. Oil, spices, bread and milk rose about 15% in the past six months. Vegetables climbed 50% from April to August. Some of the increase is due to rising demand from the burgeoning middle class, some is supply-related and some stems from the depreciation of the rupee against the dollar, increasing the cost of imported foods. Some is because the people in the rising middle class don’t want lentils, they want meat, whose price is rising accordingly.
India’s government blames the higher food prices on rising commodity prices around the world. Economists there urge the government to push through reforms to improve crop yields, which would lower prices. Agriculture is one of India’s biggest sectors, yet 40% of its output is ruined before reaching the market because of bad storage conditions or the absence of refrigeration.
Indians quip that to drive in India, you need three things: a good horn, good brakes and good luck. It has one of the world’s biggest road systems but the roads are bad, wearing down tires and increasing gasoline consumption. Only half are paved. Traffic moves slowly; the average speed in India is 40 kilometers per hour.
That has an economic impact. India estimates that its bad roads cost it $6 billion a year in lost GDP. The traffic jams are tremendously wasteful and intracity public transportation is inadequate. Indian IT company Infosys spends millions each year on buses and taxis to transport its 18,000 employees to and from work in Bangalore.
Experts say Indian infrastructure is 10 to 12 years behind where it should be. Others growl that it’s 100 years behind China. Port workers in Shanghai can unload a container in eight hours; in India it takes three days. India still relies on manual labor rather than machinery. This is one reason multinationals prefer to manufacture in China and Thailand rather than India.
India’s electricity industry is also behind and blackouts are a daily thing, including in New Delhi, Mumbai and Bangalore. Big companies and hotels keep their own generators and maintain diesel supplies to run them.
Like Russia, India suffers from endemic corruption. Money earmarked for infrastructure disappears. A study in 2005 found that 55% of the people had bribed government officials at least once.
India’s government wants to invest $1 trillion from 2012 to 2017 in infrastructure. The question is how much will reach projects and how much will fall into grasping hands.
Companies also get bogged down in bureaucracy, and the banking system isn’t developed enough either. The health care system leaves much to be desired, partly because of low government spending.
India is at such a low point that its economy could well keep sprouting like a weed for years. But the problems that accompany economic growth increase the likelihood of crises that will prevent the country from realizing its true potential.
Brazil: Burgeoning middle class, problem schools
In the last eight years, 40 million people joined Brazil’s middle class. They work and consume, and have driven economic growth.
Unemployment halved to 6% inside a decade. Some sectors are having a hard time finding working hands − in part because of the lack of adequately trained manpower.
There’s the rub. Former President Luiz Inacio Lula da Silva only had four years of schooling his whole life. Education is where Brazil falls shortest of its fellow BRICs.
One out of ten Brazilians is illiterate and many more have problems in reading comprehension. Brazilian students do poorly on international tests in math, reading and science. Brazilian 15-year-olds came in 49th out of 56 countries in reading tests, achieving roughly the same marks as 9-year-olds in Finland and Denmark.
Under da Silva, Brazil has stepped up investment in education. The number of pupils graduating middle school has quadrupled. But the quality of teachers and study methods remains much the same. Teachers in poor areas don’t want too teach and the kids drop out early to make a living. Teachers also retire early, increasing the burden on the pension system. Many fail the tests required for tenure.
The poor level of education affects the labor market. Companies have to hold training courses in reading and writing for their employees.
Silas Xavier, a taxi driver, defaulted on his credit-card bills for the third time in four years, ABC News reported in July, describing how mushrooming credit-card debt may threaten Brazil’s economic boom. Xavier owes some $2,000.
Maura Guarnieri described her “personal credit bubble” to The Wall Street Journal in September. She’d been issued four credit cards in the past year, after her husband contracted kidney disease and stopped working.
Almost one in 10 Brazilians is bankrupt. For years the banks borrowed cheaply overseas and lent money to Brazilians for consumption. The spending boom did well by the domestic economy, but households racked up debt.
Repaying loans eats up about a third of the average Brazilian’s income, far above the 16% in the United States and the average of 10% in other emerging markets. (One reason is that borrowing hadn’t been endemic in Brazil; as people rose to the middle class, they borrowed too much.)
“Brazilians are hooked on credit, just like their North American neighbors,” commented a Barclays analyst in Sao Paolo recently. The government cracked down, slapping limits on lending, which set off an explosion of shadow-economy lending. Retailers accept postdated checks to spur sales, for instance. Consumers have kept spending wildly and if there are complaints, it’s about waiting lists for durable goods. Flights fill up well in advance.
Yet the mushrooming debt is cause for worry. Brazil’s monetary system is strong and closely supervised, and even if the amount of bad debt increases, the problem has been overstated, says Yulia Vaiman, macro analyst at Tandem Capital.
Is there a credit bubble in Brazil? Opinions differ. Credit spending has increased in tandem with the development of the middle class, where living standards have risen. Yet some say it’s a red flag for an economy whose growth relies on rising consumption. Brazil still suffers from inflation pressure and has to keep interest rates high to fight it. In Sao Paolo, the price of a movie, soda and taxi ride home costs more than in New York.
China: A white elephant for every worker
There had been concerns, but China managed to leap lightly over the great financial crisis of 2008, largely thanks to a $600 billion government incentives plan. But many say the plan spawned a giant real estate bubble that threatens not only China, but the rest of the world.
A Chinese citizen earning the average wage needs 57 years to buy an apartment in Beijing. Housing prices more than tripled in the past six years. Builders sometimes prefer to sit on completed projects rather than start selling right away, figuring that prices will just increase more.
Yet a few months ago the World Bank warned that the property bubble is China’s biggest danger. The real estate market drove growth over the past 20 years and was the conduit feeding many other industries such as construction, steel and cement. For the Chinese, investment in property substituted for depositing money in banks, which failed to preserve money’s value against inflation.
The real estate market also drove banks’ growth and employment by local governments. Investment had never run so high. The leaders in Beijing found themselves torn between the urge to stop the real estate bubble from expanding further − for instance, by raising interest rates − and the reluctance to hurt a sector responsible for around 10% of China’s GDP.
The growth of the property bubble was accompanied by a constant increase in credit volume. It could be that the real problem is the credit market. More than $3 trillion in new credit has been allocated in the past two and half years. One upshot is steep investment in municipal debt.
Officially Beijing says local government debt totals $1.7 trillion (27% of China’s annual GDP), and that was at the end of 2010. Moody’s estimated a few months back that the real debt volume held by local governments is closer to $2.2 trillion. Half of that was generated in the last two years.
Most of the new debt was created because of the incentives plan China adopted in early 2009 to keep economic growth brisk.
Local governments’ job in the incentives plan was simple enough. They borrowed money from banks to build grandiose infrastructure and other real estate projects, some of them manifestly uneconomical.
The upshot has been the construction of white elephants, including whole ghost cities, as well as office and business complexes that stand empty. A recent UBS report surmises that in the coming years, defaults by local Chinese authorities could reach $460 billion.
Yet the real estate market has been slowing. Property prices have been receding in almost half of China’s cities, compared with prices at the start of the year. In September, Standard & Poor’s wrote that a 30% drop in home prices could prove a breaking point for developers and trigger a rapid downward spiral in the banking system.
The Chinese government is deeply involved in the life of the economy and the people. The capitalist world never ceases to marvel at the central government’s success in driving growth.
But by nature, government intervention creates distortions that can take years to correct. Take the intervention in procreation, the one-child policy instituted more than 30 years ago, when China was worried about feeding its people. The government wanted to slow population growth and increase savings, preventing crime, disease and unemployment.
Yet one unforeseen upshot, with the development of medical technology, has been mass abortion of female fetuses and a huge surplus of boys − which many observers suspect will stoke crime as frustrated males fail to find mates. Demographers project that within five years, China’s workforce will start to contract, and in 20 years, the young will be overburdened to support all the elderly.
The Chinese economy has other problems, too. Like India, food prices have been rising, as has inflation, which Beijing has tried to fight by raising interest rates. The Chinese economy is also unbalanced, relying heavily on exports and investments, while growth in private consumption has been slow.
As world economies groan, Chinese exports will suffer. A meltdown in the West will leave China in a world of pain, and government incentives may not suffice.
Right now Chinese economic growth is rolling along briskly and crisis scenarios are distant. But the problems are huge, and what happens in China doesn’t stay in China. It will affect the rest of the world.
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