The imminent collapse of Evergrande, the world’s most heavily indebted real estate developer, marks the end of China’s housing boom and threatens to stall more than a year of rapid economic recovery from coronavirus-induced lockdowns.
The knock-on effects of slower Chinese growth would be felt around the world. Beijing seems to be able to limit the impact of Evergrande’s financial woes to a smaller scale than an international implosion.
On Tuesday, Goldman Sachs lowered its forecast for the country’s economic growth in 2021 to 7.2 percent from 8.2 percent, citing uncertainty over how the Chinese government would manage Evergrande’s stress, as well as energy shortages that undermine industrial output.
Despite being one of the country’s biggest developers, Evergrande’s crisis is unlikely to end in a government bailout. Fed up with financial risks created by the sector’s excessive borrowing, authorities would rather guide the conglomerate through a “controlled demolition,” or managed collapse, according to Homin Lee, a strategist at Lombard Odier.
Panicked trading in global financial markets early last week, sparked by fears that Evergrande would be China’s “Lehman moment,” eased after the company last Wednesday announced it had “resolved” a domestic interest payment with creditors, while Federal Reserve Chair Jerome H. Powell downplayed international exposure to a collapse.
Evergrande has stayed silent since missing a $83.5 million interest payment on one of its offshore bonds on Thursday and entering a 30-day grace period before it defaults. The company has a further $547.6 million to pay in offshore bond coupon payments before the end of the year.
Uncertainty over Evergrande’s ability to resolve the crisis is intensified by Beijing’s determination to tackle ballooning real estate debt. Analysts question whether China can follow Evergrande’s lead and avoid a housing market crash that could cause havoc.
“Evergrande itself is unlikely a systemic risk to China’s economy and financial system,” but markets should not be complacent, Nomura analysts wrote in a research note last week. “In our view, Beijing’s determination to suppress the whole property sector, not the fallout of Evergrande, is what represents the major near-term risk to China’s growth and financial stability.”
Evergrande’s ability to accumulate $300 billion in debt — about 2 percent of China’s gross domestic product — in part reflects investors betting on a stunning creation of wealth from rural families pouring into Chinese cities. Since the 1990s, ballooning demand for homes — and government reliance on land sales for income — meant developers had easy access to credit, allowing them to aggressively borrow and build.
That growth engine is now sputtering after regulators drastically reduced the sector’s access to loans. Evergrande’s crisis is further dragging down land and home sales, in what is shaping up to be the sector’s sharpest slowdown since 2014. A recent land auction in the southern city of Guangzhou, usually one of China’s hottest real estate markets, ended with only half the lots being sold.
A prolonged slump would send shock waves through the global construction supply chain that spans iron ore mines supplying Chinese steelmakers to equipment manufacturers selling cranes and diggers.
But the economic fallout is not the only consideration for the Chinese Communist Party. Evergrande’s debt is being scrutinized by regulators as part of a broad political agenda that seeks to reduce “excessive wealth” in China and the privatizations it believes are causing social instability and inequality.
In recent months, the campaign led by Chinese President Xi Jinping has wiped billions off the valuations of China’s leading Internet conglomerates and silenced previously outspoken billionaires such as Jack Ma, the founder of e-commerce group Alibaba.
Instead of relatively lax regulation for technology giants, property developers and the entertainment industry, Xi has pledged new laws and regulations to ensure the spoils of successful private enterprises are shared across society under a mantra of “common prosperity.”
Scrutiny of the highly leveraged property sector fits squarely in that broader trend. Logan Wright, Rhodium Group’s director of China market research, said that Evergrande was not only a source of debt problems, but also a prime example of wider issues in the sector. “It’s exceptional because of size, not methods.”
For the Chinese government, which wants to introduce a better understanding of risk into the Chinese financial system, the calculus may have fundamentally changed, making it unwilling to step in to stabilize the market, Wright said.
But if authorities mishandle the situation, they could inadvertently spark further contagion. He said that the system is more vulnerable when Beijing reforms it.
Even so, “China’s goal is to reduce risk, it’s not to trigger a crisis,” said Bo Zhuang, a Singapore-based economist at Loomis, Sayles & Company, an investment management firm. A string of Chinese policymakers’ announcements meant that Evergrande bonds were classified as junk by rating agencies months ago. This is in contrast to Lehman Brothers bonds, which were considered investment-grade just days prior to its fall.
International creditors, including BlackRock and HSBC, are a low priority for government payouts, but the markets appear to already have priced in significant losses, given the bonds are trading at a heavy discount, Zhuang said.
Tamping down public anger
For the Chinese leadership, the main concern is managing domestic fallout. Evergrande could be bankrupt, leaving behind a large network of suppliers and retail investors. The company sold wealth management products to many of its employees who were lured by high returns. Many homebuyers paid out upfront to purchase apartments that they don’t believe will ever be completed.
At stake is the party’s coveted image as a successful steward of the Chinese economic miracle and its unspoken pact with Chinese citizens: We will provide opportunities to become wealthy if you stay out of politics.
So far, public anger has largely been directed at Evergrande and its billionaire founder, Xu Jiayin. A video showing an Evergrande creditor cursing the executives of the company for spending money on villas and private jets, was widely shared on social media.
Yet, further contagion that leads to plummeting house prices could spark a larger public backlash against government policies. Property accounts for 80 percent of household wealth. Homeowners of middle class homes who purchased apartments in the belief that their values would rise have protested past falls in property prices.
Faced with social unrest, the government has begun to quietly introduce policies to limit fallout from Evergrande’s expected default.
Local governments in at least eight provinces have transferred Evergrande’s funds into special custodian accounts to ensure that the money goes toward completing unfinished houses, not paying off the company’s debts, according to Caixin, a Chinese financial publication.
In recent days, at least nine municipal governments from midsize cities have placed limits on apartment discounts, out of fear that cash-strapped developers may resort to a fire-sale to meet year-end targets, a development that would further tank home prices.
In Zhangjiakou, a city of 4 million that will host Alpine skiing events during the 2022 Winter Olympics, prices had already dropped by 40 percent before the government intervened.
Only 50 minutes from downtown Beijing by high-speed rail, the city in recent years has been a popular destination for investors who snapped up new apartments hoping to sell them at a markup.
Even before Evergrande’s crisis, the struggle to break even was distressing some Zhangjiakou homeowners. In July, local police detained a man and a woman for 10 days for “disrupting public order” after they threatened to jump from a high-rise building to protest their recently purchased apartment’s rapidly declining value.
Alicia Chen in Taipei contributed to this report.