From an FT long read on Evergrande
There is enough empty property in China to house over 90m people, says Logan Wright, a Hong Kong-based director at Rhodium Group, a consultancy. To put that into perspective: there are 5 G7 countries — France, Germany, Italy, the UK and Canada — who could fit their entire populations into those empty Chinese apartments with room to spare.
This factual summary of Evergrande,
Around 29 per cent of China’s gross domestic product is related to real estate. Evergrande has a total debt exposure (including trade payables) of over $300 billion, which includes $19 billion in offshore US dollar-denominated bonds... Evergrande’s balance sheet shows 128 banks and 120 other institutions with direct exposures. This includes global investors... The company has been unable to complete many of its 1,300 ongoing projects. Apart from financial debt, Evergrande is said to have over 667 billion Chinese yuan (about $103 billion) in outstanding trade payables. It will have another 240 billion yuan ($37.16 billion) of trade payables to settle in the next 12 months, if it remains a going concern. The cash crunch has led to over $1 trillion worth of Evergrande projects being unfinished... Some estimates indicate unsold inventories of 60-65 million units across the People’s Republic of China. Mortgage lenders could therefore be in trouble as well. China’s real estate has debts of over $4.5 trillion, of which $209 billion is parked in offshore bonds.
See also this.
Any property market crash can have a large impact on the wider economy. Apart from the fact that real estate makes up 29% of the GDP, it's the major source of financing for local governments. And this is a very big concern,
An even more consequential trend for China’s political economy is the collapse in land sales by local governments, which fell 90 per cent year on year in the first 12 days of September, official figures show. Such land sales generate about one-third of local government revenues, which in turn are used to help pay the principal and interest on some $8.4tn in debt issued by several thousand local government financing vehicles. LGFVs act as an often unseen dynamo for the broader economy; they raise capital through bond issuance that is then used to fund vast infrastructure projects... This dwindling ability of local governments to raise finance to spend on infrastructure has the potential to depress Chinese growth considerably. Fixed asset investment, which last year totalled Rmb51.9tn ($8tn), constitutes 43 per cent of GDP.
After rating downgrades over threat of defaults, trading on Evergrande's yuan debt has been halted. Chinese debt assets and global equity markets have been spooked and metal and fuel prices have crashed.
The woes of Evergrande owe significantly to Beijing's restrictions on the property market, best exemplified by its "three red lines" laid down in November last year to reduce debt and oversupply in residential real estate. It involved keeping the ratios of liabilities to assets below 70%, net debt to equity below 100%, and cash to short-term debt to be at least 100%.
All this raises the question of how much pain is too much for Chinese regulators? James Kynge captures the delicate balancing act China is performing with Evergrande,
It needs to inflict enough pain to show it is serious but not so much that it renders one of the most important engines of economic growth moribund.
It's also a measure of the importance of China that it's perhaps the only country outside of US whose corporate default could have this kind of ripple effect on the world economy and global equity markets.
Update 1 (24.09.2021)
Adam Tooze refutes the Lehman analogy with Evergrande and argues that it's a deliberately brought about crisis, a "controlled demolition" to deflate the property bubble.
In terms of scale of investment, the Chinese real estate and construction sector is at least twice the size of its US counterpart and three times as important in relation to GDP. In cities it accounts for c. 17 percent of employment. Its share in local public revenue stands at about 1/3. Real estate accounts for c. 80 percent of household wealth in China, versus a share of around 30 percent in the US. The campaign to rein in this gigantic growth machine began in earnest in October 2017 when Xi gave his speech to the 19th Party Congress with the famous line: “houses are for living in, not for speculation”.
Update 2 (25.09.2021)
Atif Mian traces the origins of China's property market bubble to the post-GFC actions to stimulate the economy as global trade and its exports declined sharply. Property market, already an important driver of economic growth, assumed even greater relevance.
The government opened the credit tap and a property market bubble ensued. In fact, domestic credit as a share of GDP rose by over 80% since 2008!
He argues that more than a financial crisis, such credit explosions which finance consumption and property market have historically been followed by growth slowdowns. Accordingly, while the Chinese government may have instruments to ward off a financial crisis, it remains to be seen whether it can find out alternative engines of growth which will have to kick in as the household sector cuts back on consumption to cut their losses in the property market.
Update 3 (25.09.2021)
Jahangir Aziz writes that the Chinese actions to not bail out Evergrande is in line with the Communist Party's growth recalibration to address the emergent "principal contradictions", a central theme of the Party since 1981. The "principal contradictions" itself has undergone multiple restatements since,
After the economic destruction resulting from the Cultural Revolution, the 1981 Congress under Deng Xiaoping restated the “principal contradiction” as the tension “between the ever-growing material needs of the people and backward social productivity” instead of the “class struggle between the proletariat and the bourgeoisie” as identified by Mao Zedong. To resolve this contradiction, policies were changed and the economy reformed to deliver and sustain a stunning 10 per cent average growth over the next three decades. But the growth also brought with it extensive collateral damage, ranging from high leverage to severe environmental degradation... To align the objectives of the Party and that of all levels of government, the 2017 Congress restated the principal contradiction as the tension between “unbalanced and inadequate development” and the “peoples’ ever-growing need for a better life”. This radically altered how the Party saw China: No longer a low-income economy needing to generate millions of new jobs every year to maintain social stability, but a rising middle-income nation aspiring for a better quality of life... We view the relatively tight fiscal and monetary policies; the persistent tightening in the housing market; the re-designation of private tutorials as non-profit; the economy-wide push to de-carbonise; and letting corporates with weak balance sheets to default, as elements of the regime change foretold at the 19th Party Congress. In its latest version, the policy changes are couched in terms of the “Common Prosperity” objectives.
The Party does not want to create any more moral hazard through bailouts. And while Evergrande is big, it's not so at a macro-level and given the credit channels and both sides of the credit equation (banks and consumers) are all tightly controlled by the government, the Chinese authorities may be thinking it can take the risk without triggering a market meltdown.
The financial liabilities of the company, while large in absolute terms, make up about 0.65 per cent of China’s corporate and government debt combined (the stock of total social financing) and bank loans per se just 0.25 per cent of total bank credit. Linkages to offshore banks and financial institutions are even smaller... Despite China’s very high debt stock (close to 300 per cent of GDP), the government and central bank still retain sufficient policy space to ensure that such system-wide stress is avoided.
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