The Chinese Debt Issue
Commentary: According to financial and economic analysts, the economic crisis from Covid-19 will not lead to recession in China, but even to a very strong public economic stimulus and hence to greater future short-term debt. Some professional Western investors are wondering whether the Chinese economy can carry the new debt burden, which is necessary to push the economy forward, during and after the coronavirus pandemic.
Giancarlo Elia Valori
| 14/05/2020
Photo: Reuters
Despite the "phase one" trade agreement signed between the United States and China in January 2020, the coronavirus issue has greatly distorted the Chinese economy.
It should be recalled that China had pledged to buy 200 billion U.S. dollars of U.S. goods and "specific products" over a two-year period.
Certainly the Chinese government has reacted to the coronavirus crisis with acceptable speed, injecting a huge amount of liquidity into the economy, through the Central Bank, as well as proportionately reducing financing costs and increasing credit to businesses by 67%.
The Chinese authorities still have some room for providing more stimulus through monetary and fiscal policy, since the central government's debt alone remains below 25% of GDP and is mainly refinanced at national level.
But there is the excessive level of debt in real estate and the increase in costs for infrastructure and protection-sanitation activities, which could put the public budget at risk in the short term.
The debt of non-financial private Chinese companies accounts for 155% of Chinese GDP, but there is a strong increase in household debt, which has been going on for at least five years. The local governments’ debt is currently worth 60-70% of Chinese GDP.
There has been a significant increase in the insolvencies of companies, especially small and medium-sized ones, given the reorientation of the whole Chinese economy from the export to the domestic market, with the expansion of the formal economy, which has knocked out the companies that produced at very low cost, especially for the export markets.
This adds to the U.S. request for cancelling part of the its public debt securities held in Chinese banks.
The underlying logic is the following: China is immediately blamed for hiding news about the coronavirus and hence the cancellation of at least part of the U.S. debt held in Chinese hands is requested.
It should also be recalled that China has approximately 20% of the North American public debt available.
It is the first time that a financial operation of such magnitude is based on a "conspiracy theory", i.e. the hypothesis - currently denied by all experts - that the Covid-19 virus has been artificially processed in the Wuhan laboratories, which are located a few hundred metres from the even more famous wet market of the city.
There is purely strategic relevance in all this: China's ability to make debt is also at the basis of the Belt and Road Initiative, i.e. the economic and geopolitical project which is more disliked by the United States than we can imagine.
That is probably the U.S. real goal.
Therefore, asking for default on part of its debt held in China is a way to make China pay the bill for the pandemic and, above all, to stop the development of China as the U.S. only challenger in terms of global economic and military power.
This is one of the best moments for the United States: approximately 60 million Chinese are still in quarantine and, while SARS cost 1.5 points of GDP in 2003, nowadays - according to the most optimistic forecasts - Covid-19 is expected to cost China 2.1 points of GDP.
Hence, while the risks of recession in China were low after the January 2020 agreements with the USA, currently the combination of the coronavirus crisis and the U.S. financial and legal pressure makes us think that the Chinese recession could be fast and strong, if these two factors persisted.
A solution could be China’s acquisition of a large part of the debt of the poorest nations that the Covid-19 crisis has bankrupted.
It has already happened with Pakistan or Sri Lanka, given that the debt service granted by China has led to the actual requisitioning of the infrastructure already built in those countries by China itself. The Chinese government, however, has mainly followed the indications of the International Monetary Fund and the World Bank, which advise to cancel the debt partly or totally.
China replies to the U.S. accusation of having produced or spread a truly "Chinese" virus throughout the world by saying that the World Health Organization itself has established that the virus has no precise development area and cannot therefore be associated with any specific country.
Furthermore, China does not accept at all the fact that, while Covid-19 has appeared for the first time in Wuhan, this necessarily means that it was "born" in Wuhan, considering that the appearance or even the very traceability of the virus are issues which are still being studied by scientists.
Obviously China reiterates that the coronavirus is not "artificial", but completely natural, as all the most authoritative virologists in each country have established.
China also maintains that Covid-19 has not been "made" in Wuhan, since the P4 laboratory in that city is a partnership between China and France (with some activity even funded by the United States) and there have been no virus infections among the staff.
But all this is not enough: over 5,000 American citizens have signed a class action in Florida to claim damages from the Chinese government for the coronavirus infection.
Similar lawsuits have been initiated in Nevada and Texas, others in Minnesota and even in California.
Under international law, the legal proceedings started by the U.S. government against the Chinese government for damage resulting from Covid-19 could be worth 1.2 trillion U.S. dollars.
The legal basis for these legal proceedings and appeals is, above all, the delay with which the Chinese government provided data to the WHO, but the institutions where to appeal against China could be the WHO itself, the International Court of Justice, but also the Permanent Court of Arbitration or the ordinary civil courts in Hong Kong and the USA itself.
Nevertheless, considering that pandemics may break out anywhere, no country has an interest in "setting the precedent" for the coronavirus. What if a new pandemic were to break out in Lithuania or Madagascar?
The International Liability Act for Health and Environmental Damage caused by one country to another applied, for the first time, in a 1920 lawsuit in which a factory in British Columbia released dangerous fumes to and across the Canadian-U.S. border.
Many North American legal experts tell us that there is a parallel between the current coronavirus situation and the old dispute between Canada and the United States in which Canada paid damages without question.
As far as current private international law is concerned, in principle States cannot be sued for public activities related to their sovereignty.
To be entitled to sue China, it would be necessary to demonstrate that the activity carried out in the Wuhan P4 laboratory was completely private and hence aimed at simply manufacturing or marketing pharmaceutical products.
From this viewpoint, domestic courts can never be called upon to judge the dispute.
Furthermore, in Italy, a foreign State may still be brought to trial, but only when its activities end up infringing the mandatory principles of international law.
However, when there is no possibility of damages action, there may also be the option of an inquiry committee made up of independent members.
It could operate under the aegis of the U.N. Security Council, or even of other equally relevant international bodies.
Furthermore, according to other financial and economic analysts, the economic crisis from Covid-19 will not lead to recession in China, but even to a very strong public economic stimulus and hence to greater future short-term debt.
After the first signs of epidemic, besides other "dedicated" financial operations, the Chinese Central Bank has injected the equivalent of 170 billion U.S. dollars of liquidity into the economy.
It is probably the largest and fastest response to the current pandemic economic crisis ever provided in the world.
Certainly, the Chinese economy is now much different from the one that withstood the pressure of SARS in 2003.
Nowadays the service sector is the primary one, with a contribution to economic growth which is 40% higher than in the days of SARS.
Meanwhile, however, the outflow of capital from China is increasing. The renmimbi is about 7 to the dollar, and some professional Western investors are wondering whether the Chinese economy can carry the new debt burden, which is necessary to push the economy forward, during and after the coronavirus pandemic.
How much is China's domestic debt support capacity? 250%? No one knows until the debt to GDP ratio reaches the ceiling.
Obviously, the U.S. claim for damages will only exacerbate internal tensions within the Chinese economy and will temporarily enable the United States to economically and strategically outdistance China from it.
Again in economic and financial terms, in 2020 China will certainly record its first GDP decline since 1976, but the United States is not doing very well either.
About half of the American population is now locked up at home.
In the last week for which we have data, the cost of unemployment insurance has reached 3.5 million, the highest level in the history of the ambiguous North American welfare state.
The International Monetary Fund also predicts a reduction in world income of at least 2 trillion U.S. dollars.
The real issue is whether there will be any recovery at the end of 2020.
What are the variables at stake? Simply the amount of stimulus to the State economy, consumer confidence, as well as the number of Covid-19 infection cases.
In the worst case scenario, there will be a yearly 3.5% reduction in Chinese GDP in 2020. A second wave of crisis can be expected in early 2021, but if there is no new virus infection, China's GDP decrease is expected to level off at 2% in 2021 and then stabilize in mid-2023.
In the E.U. case, the crisis is expected to lead to a 9% GDP reduction in all Member States, which will certainly not mean a decrease in internal tensions.
On the worst possible assumption, the persistence of a significant amount of infections and of lockdowns could lead to structural recession and it would take at least four to five years to go back to pre-Covid-19 rates.
It will be necessary to reduce spending significantly, from 20 to 30%, as well as advance receipts and provide more aid to companies and consumers.
Professor Valori is President of the International World Group
Commentary: According to financial and economic analysts, the economic crisis from Covid-19 will not lead to recession in China, but even to a very strong public economic stimulus and hence to greater future short-term debt. Some professional Western investors are wondering whether the Chinese economy can carry the new debt burden, which is necessary to push the economy forward, during and after the coronavirus pandemic.
Photo: Reuters
Despite the "phase one" trade agreement signed between the United States and China in January 2020, the coronavirus issue has greatly distorted the Chinese economy.
It should be recalled that China had pledged to buy 200 billion U.S. dollars of U.S. goods and "specific products" over a two-year period.
Certainly the Chinese government has reacted to the coronavirus crisis with acceptable speed, injecting a huge amount of liquidity into the economy, through the Central Bank, as well as proportionately reducing financing costs and increasing credit to businesses by 67%.
The Chinese authorities still have some room for providing more stimulus through monetary and fiscal policy, since the central government's debt alone remains below 25% of GDP and is mainly refinanced at national level.
But there is the excessive level of debt in real estate and the increase in costs for infrastructure and protection-sanitation activities, which could put the public budget at risk in the short term.
The debt of non-financial private Chinese companies accounts for 155% of Chinese GDP, but there is a strong increase in household debt, which has been going on for at least five years. The local governments’ debt is currently worth 60-70% of Chinese GDP.
There has been a significant increase in the insolvencies of companies, especially small and medium-sized ones, given the reorientation of the whole Chinese economy from the export to the domestic market, with the expansion of the formal economy, which has knocked out the companies that produced at very low cost, especially for the export markets.
This adds to the U.S. request for cancelling part of the its public debt securities held in Chinese banks.
The underlying logic is the following: China is immediately blamed for hiding news about the coronavirus and hence the cancellation of at least part of the U.S. debt held in Chinese hands is requested.
It should also be recalled that China has approximately 20% of the North American public debt available.
It is the first time that a financial operation of such magnitude is based on a "conspiracy theory", i.e. the hypothesis - currently denied by all experts - that the Covid-19 virus has been artificially processed in the Wuhan laboratories, which are located a few hundred metres from the even more famous wet market of the city.
There is purely strategic relevance in all this: China's ability to make debt is also at the basis of the Belt and Road Initiative, i.e. the economic and geopolitical project which is more disliked by the United States than we can imagine.
That is probably the U.S. real goal.
Therefore, asking for default on part of its debt held in China is a way to make China pay the bill for the pandemic and, above all, to stop the development of China as the U.S. only challenger in terms of global economic and military power.
This is one of the best moments for the United States: approximately 60 million Chinese are still in quarantine and, while SARS cost 1.5 points of GDP in 2003, nowadays - according to the most optimistic forecasts - Covid-19 is expected to cost China 2.1 points of GDP.
Hence, while the risks of recession in China were low after the January 2020 agreements with the USA, currently the combination of the coronavirus crisis and the U.S. financial and legal pressure makes us think that the Chinese recession could be fast and strong, if these two factors persisted.
A solution could be China’s acquisition of a large part of the debt of the poorest nations that the Covid-19 crisis has bankrupted.
It has already happened with Pakistan or Sri Lanka, given that the debt service granted by China has led to the actual requisitioning of the infrastructure already built in those countries by China itself. The Chinese government, however, has mainly followed the indications of the International Monetary Fund and the World Bank, which advise to cancel the debt partly or totally.
China replies to the U.S. accusation of having produced or spread a truly "Chinese" virus throughout the world by saying that the World Health Organization itself has established that the virus has no precise development area and cannot therefore be associated with any specific country.
Furthermore, China does not accept at all the fact that, while Covid-19 has appeared for the first time in Wuhan, this necessarily means that it was "born" in Wuhan, considering that the appearance or even the very traceability of the virus are issues which are still being studied by scientists.
Obviously China reiterates that the coronavirus is not "artificial", but completely natural, as all the most authoritative virologists in each country have established.
China also maintains that Covid-19 has not been "made" in Wuhan, since the P4 laboratory in that city is a partnership between China and France (with some activity even funded by the United States) and there have been no virus infections among the staff.
But all this is not enough: over 5,000 American citizens have signed a class action in Florida to claim damages from the Chinese government for the coronavirus infection.
Similar lawsuits have been initiated in Nevada and Texas, others in Minnesota and even in California.
Under international law, the legal proceedings started by the U.S. government against the Chinese government for damage resulting from Covid-19 could be worth 1.2 trillion U.S. dollars.
The legal basis for these legal proceedings and appeals is, above all, the delay with which the Chinese government provided data to the WHO, but the institutions where to appeal against China could be the WHO itself, the International Court of Justice, but also the Permanent Court of Arbitration or the ordinary civil courts in Hong Kong and the USA itself.
Nevertheless, considering that pandemics may break out anywhere, no country has an interest in "setting the precedent" for the coronavirus. What if a new pandemic were to break out in Lithuania or Madagascar?
The International Liability Act for Health and Environmental Damage caused by one country to another applied, for the first time, in a 1920 lawsuit in which a factory in British Columbia released dangerous fumes to and across the Canadian-U.S. border.
Many North American legal experts tell us that there is a parallel between the current coronavirus situation and the old dispute between Canada and the United States in which Canada paid damages without question.
As far as current private international law is concerned, in principle States cannot be sued for public activities related to their sovereignty.
To be entitled to sue China, it would be necessary to demonstrate that the activity carried out in the Wuhan P4 laboratory was completely private and hence aimed at simply manufacturing or marketing pharmaceutical products.
From this viewpoint, domestic courts can never be called upon to judge the dispute.
Furthermore, in Italy, a foreign State may still be brought to trial, but only when its activities end up infringing the mandatory principles of international law.
However, when there is no possibility of damages action, there may also be the option of an inquiry committee made up of independent members.
It could operate under the aegis of the U.N. Security Council, or even of other equally relevant international bodies.
Furthermore, according to other financial and economic analysts, the economic crisis from Covid-19 will not lead to recession in China, but even to a very strong public economic stimulus and hence to greater future short-term debt.
After the first signs of epidemic, besides other "dedicated" financial operations, the Chinese Central Bank has injected the equivalent of 170 billion U.S. dollars of liquidity into the economy.
It is probably the largest and fastest response to the current pandemic economic crisis ever provided in the world.
Certainly, the Chinese economy is now much different from the one that withstood the pressure of SARS in 2003.
Nowadays the service sector is the primary one, with a contribution to economic growth which is 40% higher than in the days of SARS.
Meanwhile, however, the outflow of capital from China is increasing. The renmimbi is about 7 to the dollar, and some professional Western investors are wondering whether the Chinese economy can carry the new debt burden, which is necessary to push the economy forward, during and after the coronavirus pandemic.
How much is China's domestic debt support capacity? 250%? No one knows until the debt to GDP ratio reaches the ceiling.
Obviously, the U.S. claim for damages will only exacerbate internal tensions within the Chinese economy and will temporarily enable the United States to economically and strategically outdistance China from it.
Again in economic and financial terms, in 2020 China will certainly record its first GDP decline since 1976, but the United States is not doing very well either.
About half of the American population is now locked up at home.
In the last week for which we have data, the cost of unemployment insurance has reached 3.5 million, the highest level in the history of the ambiguous North American welfare state.
The International Monetary Fund also predicts a reduction in world income of at least 2 trillion U.S. dollars.
The real issue is whether there will be any recovery at the end of 2020.
What are the variables at stake? Simply the amount of stimulus to the State economy, consumer confidence, as well as the number of Covid-19 infection cases.
In the worst case scenario, there will be a yearly 3.5% reduction in Chinese GDP in 2020. A second wave of crisis can be expected in early 2021, but if there is no new virus infection, China's GDP decrease is expected to level off at 2% in 2021 and then stabilize in mid-2023.
In the E.U. case, the crisis is expected to lead to a 9% GDP reduction in all Member States, which will certainly not mean a decrease in internal tensions.
On the worst possible assumption, the persistence of a significant amount of infections and of lockdowns could lead to structural recession and it would take at least four to five years to go back to pre-Covid-19 rates.
It will be necessary to reduce spending significantly, from 20 to 30%, as well as advance receipts and provide more aid to companies and consumers.
Professor Valori is President of the International World Group
