What does the Evergrande debt crisis mean for China’s economy?

As the COVID-19 virus spread across China in the early months of 2020, some expert commentators dubbed it as China’s “Chernobyl moment” – an event that would undermine the legitimacy and rule of the Communist Party. A much more likely candidate for that title has emerged, though, in the form of the debt crisis enveloping Evergrande Real Estate Group.

China’s second largest property developer and the most indebted developer in the world with over $300bn of liabilities is out of money, and unable to meet interest payments due to both banks and foreign bondholders — though it was reported on Wednesday 22 September that some agreement has been reached to meet an interest payment to domestic bond holders. Evergrande Real Estate Group is also a kind of metaphor for the wider debt crisis in the Chinese economy. Material consequences for both China and the global system are sure to follow in the coming months.

The immediate problem is the unravelling of Evergrande Real Estate Group, which owns more than 1300 properties in more than 280 cities across China. Until now, the Chinese government has refrained from stepping in, choosing instead to make an example of Evergrande’s “capitalist excesses” to banks and others as a way to encourage more conservative methods.

Yet some sort of state bailout or restructuring is inevitable for the developer, at least to buy time. Otherwise, the financial contagion, and economic and social instability consequences of a messy default, would be catastrophic for Xi Jinping, especially ahead of the important 20th party Congress in November 2022. Consider that much of Evergrande Real Estate Group’s liabilities comprise pre-sale deposits by almost 1.5 million households, all of which would see their savings lost. Evergrande’s employees and others bought financial products that it issued to help fund itself, and they too would risk losing money in a worst case scenario. The Chinese government will not want unhappy citizens to be on the hook. We expect that rather than a spectacular “Lehman-type” crisis, China will go through a period of financial distress, which will postpone growth.

2 replies
  1. Xiu Lee
    Xiu Lee says:

    Only the timing of the “crisis” and this likely effective default today can have caught investors out not the actual event, political and market risk in China has historically largely been ignored. Yes it’s been discussed but then ignored in the headlong rush to deploy assets into markets with a headline “juicy” return. There’s plenty of money to be lost here and large fortunes will be made from previously enormous ones 😂

    Reply
  2. Kensley Harper
    Kensley Harper says:

    This is a crisis that has been many years in the making. Basically, much of China’s recent GDP growth has been driven by debt raised on the basis of an implicit government guarantee rather than credit viability. This in turn was driven by the need to meet GDP growth targets. This has been known for some time but, until now, it has always been easier to kick the can down the road rather than take corrective action. The end result is enough empty property to house the entire UK population according to one estimate and an unsustainable (even if backed by the coercive power of the state) level of debt. In my opinion, XJP’s abrupt policy shifts should be viewed through the lens of economic necessity every bit as much as blinkered ideology. The resolution of the Evergrande situation bears monitoring for reasons that extend well beyond the bondholders. We do indeed live in interesting times.

    Michael Pettis pointed out several years ago that China faced an unenviable choice. Its current model of financial repression and investment (including real estate)-led growth was unsustainable. One way or the other China was on course to transition to a lower-growth trajectory. This could either come in a controlled way or the problems could be left unattended with an abrupt and painful transition to much lower growth. We now seem to be reaching end-game on the latter path. Undoubtedly, China could simply kick the can down the road again if it wished to. Banks would lend if so instructed but that would only postpone the day of reckoning, something XJP seems to have set his face against. Unfortunately, this is a systemic, internal issue (on this point the ‘Lehman Moment’ Cassandras are correct). Systemic issues like the GFC are more painful for investors than external shocks like the recent pandemic that is true. However, China is not the US. The authorities have more levers at their disposal although economic gravity continues to apply. Again in my opinion, China’s ‘Lehman Moment’ is more likely to resemble a slow puncture than a bubble popping.

    So how does this leave the overseas Evergrande bondholders? There are so many moving parts beyond Evergrande that it is hard to say. One thing is sure though China is not Argentina and will not be so easily pushed around by the likes of Paul Singer. Overseas bondholders are at the end of the queue for rescuing behind retail investors, trade suppliers and domestic bondholders. It seems unlikely that they will get off scott-free. 30 cents on the dollar may turn out to be too much.

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