As Covid-19 swept through China in early 2020, some commentators called it China’s “Chernobyl moment,” an event that would undermine the legitimacy and governance of the Communist Party. However, a more likely candidate has emerged in the form of the debt crisis surrounding Evergrande.
China’s second-largest real estate developer and the world’s most indebted developer with more than $ 300 billion in non-cash commitments and unable to meet interest payments owed to both banks and foreign bondholders, although it is reported on Wednesday September 22 that some agreements had to deal with interest payments to national bondholders. Evergrande is also something of a metaphor for the broader debt crisis in the country’s economy. This will surely have material consequences for both China and the world order.
The most pressing dilemma is the disintegration of Evergrande, which has more than 1,300 projects in more than 280 cities in China. So far, the Chinese government has refrained from intervening, opting instead to give an example of the company’s “excess capital” in debt to banks and others as a way to encourage more conservative financial behavior.
However, some kind of bailout or state restructuring is inevitable, at least to buy time. Otherwise, financial contagion and the consequences of economic and social instability of default will be disastrous for Xi Jinping, especially ahead of the important XX Party Congress in November next year. Keep in mind that many of Evergrande’s liabilities include pre-sale deposits from nearly 1.5 million households, all of whom will see their savings lose. Company employees and others bought the financial products it issued to help finance themselves, and they too would risk losing money in the worst case of default. The government will not want unfortunate citizens to get in trouble. I predict that instead of a spectacular Lehman-style crisis, China will go through a period of financial difficulties, severely reducing growth.
China’s real estate market, valued at $ 52 trillion or four times GDP in 2019 by Goldman Sachs, has for some time been the world’s most important market, helping to boost the Chinese economy. Still, but now for all the wrong reasons. Xi Jinping and other leaders have warned for some time that the property is for living, not speculation. To curb the runaway accumulation of debt, they subjected mortgages and second home ownership to stricter rules, and in 2020, regulators introduced “three red lines” restrictions to limit the growth of both debt and the supply of new households. About a fifth of real estate units in China are vacant, and in the last year or so, chronic overbuilding has been exposed, based on the misconception of “borrow, build, and they will come.”
This year’s regulatory drive to impose tighter control on private companies may extend to housing, where high costs are seen as excessive and disincentive for larger families. A recently revived slogan “Shared Prosperity,” designed to address the country’s staggering wealth disparity, called for higher taxes on high income and capital, including the long-standing property tax. Demographic shifts, especially the shrinking age group, and first-time home buyers are also expected to weaken construction in the coming years.
Eventually, all real estate booms fail and it might be China’s turn. However, the country has not seen a significant decline in property prices, which have risen nearly 50 percent since 2015 based on BIS data alone. Lower prices would undermine Chinese consumption and therefore investment. It will also have negative effects on banks with higher credit losses and lower real estate collateral in loan contracts. Local governments, which rely heavily on land sales to finance their expenses, will be more financially stressed and less able to meet their obligations.
The exact way in which this crisis will be solved is ambiguous, but it is inevitable that the losses will be distributed in some way between creditors, investors and depositors. This will be a painful process that is likely to cost growth and jobs and, in extreme cases, can also lead to social or political instability.
Evergrande’s timing is poor too. China is still struggling with its Covid-19-free policy and faces a mix of medium-term economic headwinds alongside the harshest trade and geopolitical environment since the Mao era. Under other political conditions, the restart of China’s development model will accelerate to breathe new life into “reform and opening-up,” the redistribution of income and wealth, and the liberalization of service industries and the productive private sector. However, none of this is on Xi Jinping’s agenda. On the contrary: the previous market-oriented reform and opening-up has come to an end, replaced by a more inclusive system of government, the return of state-owned companies to “higher levels of leadership” and a strong political lean to the left.
Unlike the Lehman Brothers collapse, it is doubtful that the global economy or financial markets will take much of the immediate damage from the Evergrande turmoil if it is included in real estate, as expected. Although anxiety has already rattled stocks and commodities, especially metals, markets and producers, it may continue intermittently.
More importantly, much of the way the world currently operates depends on the continued and ever-increasing growth of China. Think of a narrative of global supply chains, exports and growth, as well as China’s geopolitical influence; Its ambition and global presence, which depend on its economic weight, can be unpredictably compromised. All of this could be in jeopardy in the next few years from the glacier named Evergrande.