Since coming to power, Chinese president Xi Jinping has had to deal with three overriding priorities. First, a domestic economy that is both slowing and increasingly unequal. Second, an adversarial geopolitical environment, resulting largely from Xi's own quest to change the regional and global status quo. And, finally and most importantly, making sure he secures a third term at the Chinese Communist party's key 20th Party Congress next year.
Enter Evergrande and its growing list of missed bond payments. This behemoth, with US$300 billion ($425b) in leverage, lies at the centre of a property sector that represents 29 per cent of Chinese gross domestic product and is more than US$5 trillion in debt.
Some 41 per cent of the Chinese banking system's assets are associated with the property sector, and 78 per cent of the invested wealth of urban Chinese is in housing. Given the millions of creditors, shareholders, bondholders and (unbuilt) apartment owners, Evergrande has become a problem for Xi politically, economically and globally.
On the domestic front, an increasingly redistributionist approach to economic policy means that neither billionaires nor housing market speculation are tolerated as they used to be. Moves to prop up Evergrande fit uneasily within Xi's "common prosperity" campaign.
Internationally, Xi wishes to avoid any perception of economic weakness or political distraction, let alone the idea that China could be heading towards a situation similar to that which crippled the US housing market during the 2008 financial crisis.
The Communist party has sought to enhance its domestic credibility by claiming that China has a more sophisticated system for dealing with crises, whether pandemic or economic, than the west.
So what is China now likely to do? Beijing's policy options are threefold: bankrupting Evergrande to send a message to the rest of the sector; propping it up because it is simply "too big to fail"; or facilitating an orderly distribution of assets.
Xi's political instincts may well be to allow Evergrande to face the music. He sees all forms of speculative investment, particularly in property, in Marxist terms: namely as belonging to the "fictitious economy" which crowds out investment in the "real economy" of manufacturing, technology and infrastructure — sectors that will seal China's global economic dominance. "Houses are for people to live in, not to speculate on," he told the 19th Party Congress in 2017.
This view is counterbalanced by an anxiety that allowing Evergrande to fail may trigger a cascading effect across not only the property sector but the banking institutions that currently finance its gargantuan levels of debt.
Fortunately, China has institutional experience in dealing with such crises. In 2018, the private insurance group Anbang was brought under state control and restructured after its collapse with more than US$320b in liabilities. The regional lending bank Baoshang was allowed to go bankrupt last year after racking up US$32b in debts; US$26b in public funds was used to help rescue creditors at an average repayment rate of under 60 per cent.
Earlier this year, HNA — one of China's largest global asset buyers with US$77b in debts — was taken over by state bankruptcy regulators and split into four separate entities. And most recently, Huarong, a state-owned asset manager with US$15.9b in losses, was partially bailed out by state-owned investor groups after its chair, Lai Xiaomin, was executed for corruption in January.
Based on these precedents, the most likely outcome for Evergrande is an orderly distribution of assets to a mix of state and private buyers. This would ensure that people get the houses they have made a deposit for, creditors are paid, and domestic bondholders skate through with just a minor haircut, while international bondholders are likely to see a comparatively bigger loss.
That may deal with the immediacy of the Evergrande problem. But if the party continues forcefully to deleverage the property and finance sectors, it could be just the beginning. Already, we've seen another midsize real estate developer, Fantasia Holdings, fail to make a US$206 million bond payment. Yet another, Modern Land, has asked to defer a US$250m payment. Evergrande's failure could already be spreading.
It would be difficult to replicate an orderly redistribution of assets across the entire property sector for every struggling firm. If the sector significantly slows or contracts, the implications for overall economic growth would be serious.
It comes on top of already declining levels of business confidence in China produced by Xi's tightening of regulatory and ideological controls on the private sector — and his parallel pivot towards the state.
The implications for the global economy from such a scenario are very real. China represented 28 per cent of all global growth between 2013 and 2018 — twice that of the US.
A significantly slowing Chinese property market would mean slower global growth, with a particular impact on commodities that service construction. This is why the world should have a profound interest in how Beijing handles the deleveraging of its property and finance sectors. It represents far more than a contest between Xi's ideology and China's economic reality.
- Kevin Rudd is the former prime minister of Australia, and is the global president of the Asia Society in New York.
Written by: Kevin Rudd
© Financial Times