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China’s Evergrande Conundrum

from C. P. Chandrasekhar

China’s Evergrande group, identified as the world’s most indebted property company with accumulated liabilities in excess of $300 billion, missed an interest payment instalment due on September 23, 2021 on bonds borrowed through US dollar bond markets. Though the company enjoys a 30-day grace period to pay up and avoid being in default, the absence as yet of any clarification on the missed instalment has increased uncertainty. Markets seem sceptical that the firm would meet in full the $129 million of interest payments on its bond issues due this month and the $850 million due by year end. Evergrande’s share prices have collapsed by more than 85 per cent over the last year.

An Evergrande default and possible bankruptcy can have repercussions in China as well as abroad, so the global media has been obsessed with this one company for weeks now. The domestic fallout would be influenced by the fact that sheer size makes Evergrande a crucial component of China’s real estate sector which is estimated to contribute more than a quarter of the country’s GDP. Property sector investment accounts for a large share of the more than 40 per cent of GDP devoted to fixed capital formation and drives China’s growth. Debt has been a core element of this growth trajectory. Property developers borrow heavily to buy and accumulate land for construction of offices and houses which are acquired by buyers, whose purchases were more often than not financed with debt, easy access to which fuelled a speculative bubble reflected in soaring property prices in multiple urban locations. Land was sold to developers by local governments, which depended on receipts from such sales for revenues that were then used to service debt totalling more than $8 trillion taken on by special-purpose Local Government Financing Vehicles (LGFVs). The LGFVs were the financing route that provincial governments used to implement huge “prestige projects” that were launched to build and shore up the reputations of provincial party and government leaders. China’s growth rode on this web of debt.

The failure of a property giant like Evergrande can tear that web apart. But this would not be the only damage. A collapse in construction would curtail demand for everything needed in construction from cement and steel to glass and fittings, adversely affecting those providing these inputs. Banks and other financial intermediaries that lent to property developers would lose heavily in the event of default. That would affect credit flow from the financial sector to businesses and households. Individual property buyers who have paid advance instalments, but have still to be given possession of their property, and retail investors who bought into the wealth management products sold by the property developers, will take a hit from Evergrande’s failure. Eighty thousand Chinese, including employees of Evergrande, reportedly hold around Rmb40 billion worth of the company’s wealth management products. Many of them have been protesting outside Evergrande’s offices demanding their money be paid back. With their savings tied up, the consumption and investment spending by investors who suffer losses because of default would depress demand even further. And Evergrande, though the biggest, is not the only property company that can fail. China Fortune Land Development defaulted in February 2021, and other construction firms are in line to follow, aggravating the crisis. All told, the end of the property bubble can cut short the revival of growth in China after a longish slowdown that followed the high growth years of the 2000s and earlier.

The adverse effects of a property market bust would not be restricted to China’s economy. To start with, demand from China has been an important driver of global growth. So, any recession in China will have repercussions for economic performance in the rest of the world. Moreover, foreign financial firms and investors, who have been plied with cheap credit by central banks pursuing easy money policies to revive depressed economies, have been diverting a chunk of that money to the Chinese market. A consequence has been significant foreign exposure to China’s financial system, with property developers alone, including Evergrande, having raised more than $220 billion in debt from the US dollar bond market. Any shock to the Chinese economy and financial system will reverberate in global markets, with analysts seeing the Evergrande saga as contributing to volatility in stock markets worldwide.

Given this fallout, global players have been surprised by the absence as of now of any concerted effort on the part of the Chinese government to intervene and bail out Evergrande, which is seen by many as being “too big to fail”. In fact, Evergrande’s troubles are being seen as China’s ‘Lehman moment’, referring to the mayhem that followed the bankruptcy of Lehman Brothers at the time of the global financial crisis of 2008. There are similarities and differences. Riding on debt, China’s property development has expanded at a pace that has resulted in oversupply relative to the actual needs of the population. But this did not appear to be a problem as investors looking to benefit from appreciation in property prices, and facilitated with access to credit, acquired multiple properties with no intention to stay in them. Evergrande’s own difficulties arose not only because it is overleveraged, or because it has accumulated too much debt. It is also because the government decided to rein in the debt financed speculative bubble in China’s property markets. To that end the government implemented its “three red lines” policy in 2020, under which the liabilities to assets ratio of property companies had to be kept below 70 per cent, the net debt to equity ratio below 100 per cent and the cash to short term debt ratio above 100 per cent. The intention was to limit leverage of property developers. Simultaneously, lending for property purchases has been curtailed, and property buyers are finding it increasingly difficult to access mortgage finance. A combination of uncertainty among buyers about the viability of developers over the long term during which they build the assets for which advance payments are made, and the brakes that are being applied on increases in mortgage lending, have slowed sales in property markets. With cash inflows to developers squeezed, and non-bank lenders holding back, servicing debt has become a problem for the likes of Evergrande, precipitating a situation of near default.

As has been the case in the past, many analysts see in the troubles in China’s property and financial sector the beginning of the end of the country’s growth story driven by credit financed speculation by local governments and the private sector. However, the Chinese government is not faced with a problem that it finds difficult to address. Rather, by clamping down on excess borrowing the government has created the crisis in the property sector. Moreover, the government as of now shows no signs of pulling back from its policy of reigning in the speculative surge in property markets, nor is it rushing to bail out Evergrande, buying into the argument that the company is too big to fail. This reticence is visible despite the possibility that if the property bubble suddenly bursts, the fall in prices could wipe out the wealth of many ordinary Chinese who bought property when prices were high, or who have invested in financial products property companies sold with the promise of high returns. Though expectations are that the government would finally relent and intervene, the delay in its intervention has resulted in palpable uncertainty in markets within and outside China. Would the government relent, that is the Evergrande conundrum.

The thinking behind the actions of the Chinese government or the absence of them is not all too clear, other than for the fact that it has clearly decided to rein in the speculative bubble. One explanation for the government’s stance is that it perceives inequality as having reached levels where it threatens its legitimacy and that of the Communist Party, with the unaffordability of housing for the ordinary citizen being an aspect of that problem. This is in keeping with the recent official emphasis on the pursuit of “common prosperity” rather than just growth and wealth creation. Another explanation could be the need to rein in wealth accumulation by private sector barons, China’s version of the Russian oligarchs, who might seek to extend their power and influence to the political arena. As President Xi Jinping consolidates control over state and party to ensure a long innings in power, it possibly is not enough to keep party insiders under control. The increasingly powerful billionaires in the business world need to be reined in and the accumulation of excess wealth that gives them power curbed. Moves against a range of tech giants such as the Ant Group and Didi Chuxing suggest that this is high on Xi’s agenda. It also could be one motivation for new policies in the property sector.

  1. Ikonoclast
    October 15, 2021 at 12:01 am

    There will be no solutions without radical solutions. It’s amusing, in a black humor kind of manner, that a supposedly socialist country, China, has these problems. I guess this merely proves the contention that China is essentially a state capitalist system, now inextricably enmeshed in the global capitalist system.

    The problem is letting financial capital rule, at all. In the end, the solution must rest in the abolition of financial capital, the abolition of money and the abolition of debt. Half measures will not do. People need to start challenging their own thinking in radical ways. To reiterate, we have to imagine the radical abolition of debt, financial capital and money, in that order.

    Let us start with debt. Michael Hudson’s debt jubilee idea is excellent but it halts before the most radical step possible. Debt default and debt jubilee only occurs after debt creation. What must be imagined is the abolition of debt creation. Why must debts ever be created? We must challenge our thinking at this fundamental level.

    Debt exists to permit consumption before (net) payment. Via debt, people are permitted to front-end consumption and “pay” for it later. The “pay” word does have to have scare quotes around it, for the consumption is real (real resources) but the payment initially is notional (money). In the second round of effects, payment becomes real as the (usually) enforced future opportunity cost on consumption. One’s own consumption, personal or firm, is reduced in the future to “pay” the debt in money. However, this does not always apply as we see in default and jubilee.

    The issue gets more complex again. While money can go into the negative, or the negative column in accounting, real human consumption can go to zero (starvation and death of humans) but it cannot go into the negative. There is a dis-junction here between the real and the nominal. This is the very and ultimate dis-junction which default and even jubilee exist to rectify.

    However, the radical question to ask is this. Why create debt at all? Why is it necessary in the first place? In a functional family, this kind of debt generally does not exist. I do not present my son and daughter with a A$500,000 debt each on their 24th birthdays. I choose “24th” and the amount in question as my empirical experience in my Western middle class milieu has shown that I supported them, up to tertiary education,to this age and the amount is about right too in current dollars.

    My children receive their “jubilee” (let us call it that to link the concepts) in advance when it develops them, not in very partial arrears after its initial partial repayment enforcement has crushed them. If a society were functional and not dysfunctional, it would do the same thing.

    The first imaginative challenge here is to imagine how a society could run without debt. I open the debate (in a reply sub-thread if necessary). Hint, it will have to be very socialist and radically non-capitalist via the abolition of financial capital itself. If we cannot begin to imagine such solutions then we are orthodox not heterodox and conservative not radical. If we don’t run into real problems, even at the theoretical and conceptual stage, it would be because our models are not dealing with the real, including real human natures (plural for the complexity). Second hint, at some point other social power and control mechanisms will be necessary upon the abolition of capital because capital represents and is backed by social power and control.

    It won’t be easy. It could get messy. But as our current trajectory under capitalism is to rapid, complete and utter collapse we really have no option but to try radical solutions or else destroy the biosphere and collapse civilization. Decision time approaches.

    • October 16, 2021 at 7:11 pm

      Thanks to Chandrasekhar for giving us some background to discuss and thanks to Ikonoclast for posing the theoretical shortfall.

      I would offer that we may need to re-conceptualize money itself, thereby rearranging our concept of capital. My present thinking is to begin with what a bank checking account really is; to have bank checking account is to have purchasing access into the general economy.

      There are two ways to get a positive balance in a checking account: Earn money and then make a deposit OR borrow money from a bank and let them give you money.

      Either way, with a positive balance in your checking account, you have access to the current economy.

      Next, begin at this time point with money in place from two methods of gaining positive balances. Going forward, you will see an increased demand for those things being sold and those things that can be built.

      If demand is later judged as being too strong, we can only say that too much borrowed money has been made available; there is too much access into the general economy.

  2. Ken Zimmerman
    October 25, 2021 at 12:45 pm

    This story sounds familiar. During the 1990s Japan constructed its economy–in fact its entire society–on debt. Specifically, property (land and buildings). At one point Tokyo was valued at $1,000,000 per square inch on the books of many Japanese banks. In America the entire westward expansion was paid for through land speculation. Land already claimed by over 200 indigenous communities. And let’s not forget all the European powers that continually claimed one slice or another of North America. Debt is woven into the fabric of most societies for over 5,000 years in a variety of forms.

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