Understanding the Connection between Foreign Investment in China and the Evergrande Scandal
China’s economic landscape has been facing numerous challenges, including a sluggish economy and U.S. sanctions on its tech firms. Amidst these difficulties, the Chinese government has been trying to promote the opening of its economy to foreign investment. However, the recent Evergrande scandal serves as a stark reminder of why foreign firms are hesitant to do business in China.
Evergrande, a Chinese real estate developer, has most of its business assets based in mainland China. The company has not made any debt payments in over two years, and despite a Hong Kong court ordering its liquidation, the likelihood of Chinese courts and local governments enforcing the ruling seems uncertain. With debts amounting to around $300 billion and minimal cash reserves, Evergrande’s prospects are grim.
Adding to the company’s troubles, Beijing has accused Evergrande of inflating its revenue by an astounding $87 billion. To put this figure into perspective, the alleged amount of revenue fabricated by Evergrande is greater than the GDP of 140 nations or approximately two-thirds of the world’s countries. Of particular interest is Beijing’s scrutiny of PricewaterhouseCoopers, the accounting firm that served as Evergrande’s auditor.
So how does the plight and fraudulent activities of a predominantly Chinese company in a sector with minimal foreign competition explain the decline in foreign direct investment (FDI) in China?
China, once known as a low-cost destination for basic manufacturing, is no longer a low-wage country. In fact, China’s average wage surpasses that of many regional competitors such as Vietnam and India, as well as more distant competitors like Mexico. This shift in labor costs has prompted companies to explore alternative investment options. However, it is important to note that there are numerous other factors that come into play when executives consider making investments.
One significant reason why Evergrande’s troubles impact FDI is that they reflect the behavior of Chinese consumers, who are burdened with substantial debt and higher debt-to-income ratios compared to individuals in Western countries. This is evident in consumer spending patterns, with domestic automobile sales currently below 2016 levels and many products experiencing sluggish growth. For foreign enterprises looking at long-term investments, this sluggish growth does not indicate an attractive market.
Another aspect often overlooked is the impact of Evergrande on foreign investors. International investors frequently express concerns about the lack of certainty regarding representations made by the Chinese government and potential investment partners concerning rule of law, policies, and the credibility of documentation, ranging from contracts to financial statements.
For years, Evergrande engaged in revenue inflation of approximately $87 billion and concealed hundreds of billions in debt. The company has failed to repay creditors for over two years, with no clear resolution in sight. Foreign investors dealing with authoritarian regimes may tolerate certain aspects but prioritize policy consistency, economic stability, and legal certainty. China, however, lacks these fundamental elements of a functioning modern economy, from the rule of law to reliable financial statements.
Foreign investors do not solely base their decisions on labor costs; they also consider future returns and investment risks. Evergrande’s situation sends a clear message to international investors that China’s future prospects are dim and that crucial elements like the rule of law and accurate financial reporting cannot be relied upon. While Evergrande primarily operates domestically in China, it serves as a warning to international investors to steer clear.
In conclusion, the Evergrande scandal highlights the challenges facing foreign investment in China. The country’s efforts to open up its economy are undermined by issues such as inflated revenue, hidden debts, and a lack of legal clarity. These factors, coupled with China’s rising wages and sluggish domestic market growth, have deterred foreign firms from pursuing investments in the Middle Kingdom. As China strives to regain investor confidence, it must address these fundamental concerns to attract foreign capital and foster a thriving investment environment.
