Evergrande – a Test of China
For several months, the financial world has been watching with concern the evolution of Evergrande Group in China, whose financial problems have conjured up the specter of an economic contagion that can destabilize not only China's opaque financial system but also that of a world in which China has assumed a central role of the economic engine. China's biggest real estate company is, in some ways, emblematic of its explosive business model in the world's most dynamic economy. The company has more than 770 projects in 200 Chinese cities and has nearly two million apartments to deliver to buyers who, in some cases, have pre-paid the delivery price in the overheated real estate market of this country. The non-delivery of these units could generate social disturbances and affect the trust of the population in the economic governance of the country provided by the Communist Party, whose "Chinese dream" and "national regeneration" have an important economic component based on ensuring the prosperity of the common Chinese. After a series of delays in due bond payments, Evergrande found last-minute resources to make some payments and resume construction, sparking theories of government involvement. At the same time, even policies of the government precipitated this crisis against the background of the attempt to restore financial order in an economy characterized by speculative bubbles, primarily in real estate.
Evergrande – the dream of unlimited growth
The Evergrande Group is, in some ways, a typical example of the Chinese business model. In the country's fast economic development, the government relied on channeling the savings of the population, which has a cultural predilection for assiduous saving, to state-owned and nominally private companies but with strategic roles or connections to the government, to finance fast development at the lowest possible cost. China's extraordinary infrastructure, including the largest high-speed train network in the world, investments in high-tech production capabilities, but also acquisitions of "crown jewels" in the West and other countries (companies and strategic resources) or investments under the global strategy umbrella of the Belt and Road Initiative relied on these resources. Evergrande has expanded quickly, covering all market segments and responding to a seemingly insatiable demand for modern urban housing in developed and developing areas of China against the background of massive urbanization. At the same time, like many other companies, access to cheap credit allowed Evergrande's leaders to expand into other areas, associated not only with real estate management, but also with a sparkling water brand, a football team, and a brand of electric cars. Others were co-interested in the company's development – local authorities in China derive 40% of their income from real estate deals, by selling land to developers. The interest is also that new real estate projects, especially those in adjacent urban areas, generate taxable economic activity and an increase in the taxable value of properties in the area, through the development of the associated infrastructure (transport infrastructure, industrial areas, etc.). During its development, Evergrande's liabilities reached over $300 billion, or 2% of China's nominal GDP. Before its financial problems became obvious, the company had begun borrowing from its own employees. Once the magnitude of Evergrande's working capital problem became apparent, problems with non-payment of debts arose, and some contractors were paid with unfinished apartments.
The specter of another contagion
The primary financial effect of Evergrande's crisis has perhaps been exaggerated – only $20 billion of its debt is held directly by external creditors (who have already shown payment delays). The fear is that Evergrande's plight will not spread to other over-indebted real estate companies, and Evergrande's bad debt exposure will trigger a chain reaction in China's financial system, whose expansion has produced fears about the real rate of non-performing loans. A domestic crisis would affect the rest of the world, which depends more and more on Chinese consumption and investment for economic growth. Also, through complex financial linkages, like the 2008 crisis triggered by the collapse of Bear Stearns and Lehman Brothers, financial contagion could occur beyond China's borders. These fears validate the idea of China's increasingly important role in the global economy and its integration with the rest of the world not just as a factory for low-value-added products. Evergrande appears to be trying to avoid insolvency and reorganize its debt. It tried to sell related businesses and other assets to obtain liquidity with which it could finish ongoing projects. Reports have emerged that the company's multi-billionaire founder Hui Ka Yan has begun liquidating his own assets or mortgaging his properties to buy time. It's unclear how long it will earn, considering the fact that, during 2022, the company has to pay $36 billion to bondholders and $91 billion to suppliers of goods and services.
The main economic field in which Evergrande operates lends itself to explosive growth – real estate values in China have seen massive increases, and demand doesn't seem to be slowing down. The downside of mobilizing the savings of ordinary Chinese is the low-interest rates offered to depositors. In this situation, the Chinese turned to areas that would bring them a higher profit – the real estate sphere was preferred, but also gold, cryptocurrencies, or special semi-regulated investment vehicles from the shadow financial-banking sector. These dynamics produced speculative bubbles whose scale became concerning to the government. During a speech before the Party, President Xi Jinping defined "three new mountains" to be conquered – the extraordinary price of real estate assets, the rising cost of education, and the cost of the healthcare system. All are important, but especially the first, because in Chinese culture a young man cannot marry unless he has a home and, increasingly, a car (and the income to support these purchases). The problem is widespread, with peripheral apartments in big cities costing hundreds of thousands of euros, compared to salaries of one thousand euros. The price of an apartment in Beijing quadrupled between 2001 and 2019, while prices in the US rose by just 80%. The perspective of a growing segment of the population socially unanchored because they could not afford the asset necessary to start a family is a cause for concern because, in all of the overpopulated and/or very young countries of the world, young single men are the segment most likely to become radicalized or agitate for radical political change. Therefore, the Chinese state is expected to send strong signals that it will support the delivery of Evergrande's remaining unfinished projects. In the end, the entire Chinese state precipitated the (probably inevitable) crisis of Evergrande, through the "three red lines" in the financial field imposed last year on real estate companies to limit their indebtedness. For Evergrande, it meant a shock to its model based on continuous debt because it no longer had the possibility to refinance. By imposing these red lines, the state has accepted the possibility of painful adjustments, and Evergrande's experience would be intended to act as an example for other companies, which should reassess the sustainability of their expansion strategy. Following this line of ideas, the Chinese state should not even try to save Evergrande, in order not to generate moral hazard in the calculation of economic actors who would anticipate that "too big to fail" in the Chinese version gives them the license to continue the expansion having the state as the savior of last resort. Such a calculation also influenced Western thinking on the issue of the financial crisis, where the first reaction was to protect small depositors and let the affected banks fail, forcing shareholders and large creditors to accept losses. Things haven't moved in that direction because a consensus (now contested and criticized) has emerged about the systemic risk of letting banks fail. Perhaps the Chinese government will have more discipline and risk appetite as long as it shelters the general population affected by Evergrande and other companies like it.
For Evergrande, 2022 will be key to its comeback prospects. At the same time, Evergrande can be a model (positive or negative) of state intervention in the economy to defuse the potential for financial chaos of overextended and over-indebted companies following decades of massive growth under China's typical growth model. The stake is greater than the controlled break of bubbles in China's economy - the government is concerned with an economic transition to a new model of economic development for the nation, because the limits of the old model have been reached and, in the absence of change, China would stagnate in a "middle-income trap". The Huawei phenomenon and the advance made by China in the field of emerging technologies (artificial intelligence, biotechnologies) represent a facet of this transformation, the one in which China becomes a producer of innovation and an exporter of products with high added value and high technological contribution. Other facets are China as a consumer market, China as a capital exporter, and China as a technology standard-setter. Evergrande represents growing pains, not the end of the Chinese Dream, but let's not forget that the secular stagnation of Japan in the 1990s after the momentum of the previous decades when it seemed ready to conquer the world economically began with the bursting of some speculative bubbles including the real estate market.
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