“The Lehman Brothers moment in China”: the Evergrande crisis shakes the economy | China


The crisis in Evergrande, China’s second-largest real estate company, is the biggest test yet of President Xi Jinping’s efforts to reform the debt-ridden behemoths of the Chinese economy. It could also be the most important test that the Chinese financial system has faced for many years.

As angry protesters occupied the struggling property developer’s headquarters in recent weeks, some analysts called the Evergrande crisis a “Lehman Brothers moment in China.” Only this time it’s about a credit-fueled homebuilder who suddenly can’t pay off his $ 300 billion debts, rather than a blue chip investment bank that many thought was too big for. go bankrupt but that was thrown to the wolves 13 years ago.

While there may be parallels, the more extreme prophecies of doom for China may not be more correct than the assumption that Beijing will simply step in and bail out Evergrande to ensure that the fallout from l failure of a real estate giant does not spread to other sectors of the Chinese economy.

“It looks like we have already started the process of financial distress. As the risk of insolvency increases, the behavior of sales agents, homebuyers, suppliers and other stakeholders changes in ways that further undermine revenues and increase expenses, ”said Michael Pettis, professor of finance. at Peking University. “Once this process begins, conditions can quickly deteriorate unless someone like the government steps in to secure the payments.”

As the Evergrande turmoil continues to brew, the pressure on China’s real estate sector is felt far beyond a single developer. August data released on Wednesday suggests national home sales by value fell 19.7% year-on-year, the biggest drop since April 2020. Home price growth has also slowed.

The question is how Beijing should intervene – if it is going to do it at all. Some analysts believe he will attempt to save part of Evergrande with a “politicized hierarchy” of creditors led by small investors and homebuyers who marched into Evergrande’s offices this week to claim their money. Such a public protest is rare in China, and Beijing cannot risk it escalating into a narrative that elites get rich at the expense of ordinary people.

Protesters at Evergrande headquarters in Shenzhen, southeast China. Photograph: Noel Celis / AFP / Getty Images

As of Tuesday, with the company founded by former steelmaker Xu Jiayin 24 years ago expected to default on two key bank repayments, major banks and financial institutions face at the prospect of a drastic haircut of over 75% because the price of saving the little guys.

But the key question is: will it work? The company shocked the market this week by admitting that it cannot offload its assets quickly enough to stop the bleeding. Its stock price collapses and trading in its bonds is suspended. It could get complicated, analysts say.

“The nightmare scenario is an inflammatory sale of Evergrande’s assets that turns a healthy market correction into a rout,” said Gabriel Wildau, China political risk specialist and senior vice president of consultancy firm Teneo.

The potential time bomb has been running for a few years. The Chinese housing market has become extremely inflated by years of cheap credit and is put by conservative estimates at 16% of GDP, although some estimates put that figure at 25% – far more than the proportion of Western economies.

But the handy fruit of debt-fueled growth is long gone. In 2007-08, about 6.5 billion yuan ($ 1 billion) of new credit was needed to increase GDP by about 5 billion yuan per year, according to the IMF. In 2015-16, it took over 20 billion yuan of new credit for the same growth.

This means that it becomes much more expensive to repeat the trick as more credit is pumped into the system for ever lower impact. Ultimately, there has to be a calculation and the crisis in Evergrande suggests that the cycle has finally caught up with the poster child of the Chinese real estate market miracle.

“It is an insoluble problem. As long as Beijing, for political reasons, chooses GDP growth targets that exceed the underlying growth rate of the economy, it needs an increase in debt to meet those targets, and this increase in the debt requires implied guarantees or moral hazard, ”Pettis said. “They can’t really get one without the other.”

This is perhaps the biggest headache for Beijing when it tries to make a reformed economic model work. Shortly after coming to power in 2013, Xi said China should “focus on improving the quality and returns of economic growth …

Since Xi’s speech, a series of regulations have been introduced for various sectors of the Chinese economy, for example the so-called “three red lines” for developers selected in 2020, which severely limited their borrowing capacity. .

Experts agree this is where the rot finally set in for Evergrande because, as house prices began to cool following regulatory crackdown, the company could no longer borrow. as much to cover his losses. Some say the way Xi deals with the implosion in Evergrande will be the “most serious test” of his resolve to carry through with his reforms.

Xi Jinping.
Xi Jinping’s goal of reforming the Chinese economy carries the risk of causing a debt crisis. Photograph: Xinhua / REX / Shutterstock

James Shi and Simon Lee of Hong Kong-based data analytics firm Reorg said Beijing’s priority would be to keep Evergrande operating – even in zombified form – in order to complete the estimated 1.4 million homes that the company has pre-sold.

“This is the top priority for them and for the government,” they said. “No one wants thousands of angry people asking for their money.

“This means that other immediate creditors such as suppliers should expect not to be paid immediately. There is also plenty of anecdotal evidence that Evergrande offered apartments as payment in kind to vendors and contractors.

They said larger institutional creditors were not a priority and would most likely have to agree to a government-orchestrated corporate restructuring. Foreign holders of Evergrande’s dollar-denominated bonds – which total around $ 20 billion – would not have much to say about what happened and would therefore face a write-off, analysts said. They would likely sue their money in international courts.

However, the big question that hangs over this is how long such a process could hold off a wide range of creditors while the business continued to operate and meet its construction obligations.

Damien Klassen, who manages millions of dollars at Nucleus Wealth in Melbourne, Australia, said Xi should be applauded for trying to make serious changes to an unbalanced economy. The problem is, it could get out of hand.

“Xi may think, ‘If I have to break a few eggs, I break a few eggs.’ I’m sure he would prefer 25% of the economy not go to the housing industry. Xi wants to change society, make home ownership more affordable. This is not a bad thing. But can he get away with it? He could end up with a debt crisis.

“The problem is that the banks have lent each developer the same way, which has seen contagion across the industry. There will be uncertainty as to who will take the bad debts and then it will be the whole industry that gets no credit, not just Evergrande. Nobody knows what’s going on, so you don’t know which real estate companies will go down next. “

Most observers agree that the state will be able to orchestrate a soft landing that Western governments managed 13 years ago. Wildau points out that the Chinese banking system survived a stress test this month by regulators who took into account defaults on home and developer loans exceeding the likely impact of a market meltdown. Evergrande. Evergrande’s $ 305 billion liability is roughly half of Lehman’s, and the West did not have the kind of regulatory control available to Beijing to defuse the situation.

However, whatever happens, and even if Evergrande lives to fight another day, analysts at Reorg say the Chinese real estate market is already in crisis as companies rush to get out of debt.

“The impact is already being felt in the industry – it is deleveraging very quickly. It is much more difficult for companies to raise funds, as evidenced by the very high yields on their bonds, ”they said.

Capital Economics agrees that while a soft landing is designed, the real estate sector that has driven China’s growth for 25 years is entering a period of decline that could have a profound effect on the world’s second-largest economy.

Even reversing the red lines wouldn’t make much of a difference, they say, as land and home sales were already down, in part because China’s slowing population growth is acting like a natural disruption in the market. housing. There are fewer young adults than 10 years ago, as evidenced by a 31% drop in marriages between 2013 and 2019.

“Relaxing regulatory controls on the sector would not change this fundamental constraint,” said Mark Williams, chief economist at Capital for Asia. “Construction, a key driver of growth and demand for raw materials in China, will slow considerably over the next few years, whether the economy escapes the current crisis or not. “

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