Commentary
Some clarity emerged from the China Evergrande saga as the embattled real estate developer triaged its finances by electing to forego paying offshore bondholders in favor of conserving cash to pay Chinese customers and stakeholders.
After weeks of customer protests, credit downgrades, and rumors of default, Evergrande elected to pay onshore bondholders and was directed by the Chinese Communist Party (CCP) leadership to conserve operational cash flows and continue to build homes for depositors.
Who were the offshore dollar-denominated bondholders Evergrande left to dry? None other than China-bulls BlackRock, HSBC, and Swiss investment bank UBS. Or more accurately, the investors in their fund vehicles will be hurt.
From the CCP’s perspective, it was necessary triage. Evergrande has been tottering on the brink of insolvency for years. Its massive debt load—more than $300 billion in liabilities—was going to come to a head at some point, and Beijing’s hope is to manage an orderly restructuring of Evergrande as much as possible.
There has been a lot of ink spilled on whether Evergrande’s downfall would cause a “Lehman moment” for China. And it very well could, in the sense that recent developments could destabilize an already fragile Chinese property market, a market that has been paramount for China’s recent economic growth as well as for the wealth accumulation of its burgeoning “middle class” over the last few decades.
In the grand scheme of things, Evergrande isn’t that important. Beijing always knew Evergrande was in trouble, and the company’s fate was sealed as soon as Beijing announced in January 2021 the “three red lines” policy imposed on the country’s property developers.
In short, the “three red lines” policy was aimed to force deleveraging of China’s grossly indebted property developers. It put strict criteria of financial ratios and metrics on property developers to clamp down on excess borrowing. It was going to be challenging for China’s property developers, all of which carried high debt levels, to meet those requirements. At the time, UBS analysts published a note to investors in January that the policy would “open up opportunities for bond investors.” At least UBS put its money where its mouth was.
Beijing is attempting to solve long-standing ailments within its property sector. And if Evergrande collapses, then that’s the cost it needs to pay to correct the market. China’s property market has around 80 million excess supply of housing units and urban apartments are in the range of 20-40 times average workers’ annual wages. Something has to give.
China looks to steer the property market away from the “build build build” model of the past. And in doing so—and to avoid a “Lehman moment”—Beijing needs to ensure that the overall stability and faith in the property market does not collapse along with Evergrande. It needs other property developers to pick up projects Evergrande may abandon, for local governments to step in where necessary to reimburse depositors where Evergrande cannot, to maintain social stability, all the while ensuring other large developers do not topple along with Evergrande. So market watchers now are keeping a close eye on Evergrande peers such as Country Garden, Sunac China Holdings, and Vanke.
But the cracks are already getting bigger. A local office of developer Sunac appealed to a municipal government in Zhejiang Province for “policy assistance” recently as the company struggled through a period of slowing sales, according to a Sept. 24 Financial Times report.
One gets the sense that CCP regime boss Xi Jinping himself is at the helm in reshaping China’s economy. Such deep cuts are impossible without his explicit sign-off. Vice Premier Liu He, Xi’s economic advisor and the country’s top trade negotiator during the last few years, has effectively been sidelined. Liu reportedly had to hold Mao-style self-criticism for allowing ride-hailing company Didi Chuxing to go public in New York.
But Xi needs to handle matters carefully to avoid a long period of stagnant growth and risking political backlash. He already has a full slate of regulatory and social changes to push through, from crackdowns on the technology industry, to heavy-handed regulations over playing video games, to increasingly Marxist-Maoist social commentary, and more recently, China’s full ban on cryptocurrencies as it attempts to exert greater control over its people and markets.
Are recent developments a sign that Xi is serious about altering China’s development model? And does he have enough political capital and social stability credit to pull it all off? That’s a high-wire act for Xi, who is attempting to secure a controversial third term as the Party’s General Secretary next year.
It remains to be seen if he is successful in doing so. But one thing is certain, China’s real estate-driven “economic miracle” of sizable annual GDP growths is over.
