As China faces a sluggish economy and pressures on tech firms from U.S. sanctions, Beijing continues to tout its ongoing struggle to open its economy and country. However, Evergrande provides a lesson on why foreign firms are reluctant to do business with the Middle Kingdom.
Evergrande is a Chinese real estate developer with almost all its business assets in mainland China. It has not made any debt payment in more than two years, and even though a Hong Kong court has ordered it liquidated, the possibility that Chinese courts and local governments will enforce the ruling seems remote at best. With approximately $300 billion in debts and almost zero cash, this company has minimal prospects.
Beijing recently accused Evergrande of inflating revenue by a staggering $87 billion. To put that figure in perspective, the amount of revenue Evergrande allegedly made out of thin air that does not exist is greater than the gross domestic product of 140 nations, or roughly two-thirds of the world’s countries. Notably, Beijing is scrutinizing the accounting firm PricewaterhouseCoopers, which acted as Evergrande’s auditor.
So how do the struggles and fraud of an almost purely Chinese company in a sector with very little foreign competition explain the fall in foreign direct investment (FDI) in China?
Long thought of as the low-cost destination for basic manufacturing, China is no longer a low-wage country. China exceeds the average wage of many regional competitors such as Vietnam and India and even farther afield competitors such as Mexico. Companies seeing this are considering other options, but as any executive considering an investment will remind you, many other factors enter the equation.
The first reason Evergrande matters to FDI is that it is indicative of the behaviors of Chinese consumers, who are significantly indebted and face higher debt-to-income ratios than most people in Western countries. This shows up clearly in purchasing signals. Domestic automobile sales are now below where they were in 2016. Many products are facing very sluggish growth. To a foreign enterprise looking at an investment with a 10-year time horizon, sluggish growth does not signal an attractive market.
There is another frequently overlooked reason that Evergrande matters to foreign investors. A common complaint of international investors is that there is no certainty on the representations provided to them by the state on matters of rule of law or policy through potential investment partners and whether the documentation, from contracts to financial statements, actually means anything.
For years, Evergrande inflated revenue by an alleged $87 billion and hid hundreds of billions worth of debt. It has not paid creditors in more than two years, and there is no legal end in sight regarding what will become of it. Foreign investors will deal with authoritarian governments and prefer them in some ways, but they prioritize policy, economic stability, and certainty. China, from the rule of law to financial statements, has neither.
Foreign investors do not merely look at the labor cost but also at the future return and risk of the investment. Evergrande is telling foreign investors that the future is not bright and that the basic elements of a functioning modern economy, such as the rule of law and financial statements, cannot be counted on in China. Evergrande may be a primarily domestic firm in China, but it is telling international investors to stay away.
