China’s Evergrande crisis has far-reaching implications
The crisis surrounding indebted Chinese real estate developer Evergrande has faded from the “headlines” – at least for now – but its implications for the Chinese economy are emerging more clearly.
The Evergrande crisis was sparked by a decision by the Chinese government in August to toughen regulations on access to credit – the so-called three red lines – over fears that debt build-up, especially in the industry. real estate, does not threaten to create the conditions for significant financial turmoil.
Evergrande was hit hard by the influx of money needed to fund its business model because it fell well short of the new requirements. But the problems facing Evergrande, which has failed to pay interest on dollar-denominated loans, extend across the real estate industry.
This week, Bloomberg released a list of 10 real estate companies, excluding Evergrande and others that had defaulted, now facing major problems.
First on the list was Shenzhen-based Fantasia Holdings, which operates across China, including Guangdong Province and Shanghai. On Monday, Moody’s downgraded the company further, citing its “increased refinancing risks due to weakened access to financing and a large amount of debt maturing.”
A 2024 dollar bond issued by the company fell to 31 cents on the dollar from 98 cents when it was issued in March. Its share price on the Hong Kong stock market has plunged 58% this year and it holds $ 4.2 billion in cash and cash equivalents against liabilities of $ 12.9 billion.
Other companies have shown similar trends, but not as extreme.
A case in point was China South City Holdings, which is based in Hong Kong and has projects in Shenzhen and Nanchang. S&P Global revised its outlook for the company to negative this month, saying it may have to “reduce its cash reserves to meet large offshore maturities” and that it “may not be able to refinance itself. at reasonable costs “. A 2023 bond that was 93 cents on the dollar when it was issued in March fell to 61 cents and the company’s stock price has fallen 43% this year. And the list continues.
The crisis in the real estate market has profound implications for the Chinese economy as a whole due to the role that real estate development and land sales have played in economic growth.
An article this week in the Economist provided some facts and figures on its importance, noting that the turbulence could jeopardize everything “from local government and household finances to the country’s growth model”.
Residential investment represents 15% of China’s gross domestic product (GDP). But according to the calculations of economists Kenneth Rogoff of Harvard University and Yuanchen Yang of Tsinghua University, once construction and related industries are added, real estate development accounts for 29% of GDP.
Their article traced the origins of the crisis to changes made by the Chinese government in 1994 when the central government overhauled the tax system and local authorities lost much of their income. They have also been prevented from going into direct debt, while being tasked with meeting high growth targets, sometimes exceeding 10% per year.
Rogoff and Yang explained that “Selling land became one of the few things city officials could do to generate income, which in turn would fund roads and other public works. They could also set up businesses that could borrow from banks and get into debt from other sources. “
“This arrangement,” the article continued, “meant that economic growth was closely tied to the real estate boom,” with Chinese leaders encouraging the process “for almost 30 years.”
According to the article, between 1999 and 2007, the amount of rural land transferred to urban use increased at an average annual rate of nearly 23 percent and sales of public land increased by an average of 31 percent per year. .
In 2008, the Chinese economy suffered a severe blow with the loss of some 23 million jobs with the onset of the global financial crisis. Fearing the eruption of working-class social struggles, the Chinese government has taken significant stimulus measures, amounting to $ 586 billion, much of it in the form of loans and shadow bank funds for property developers. . As a result, in 2010, land sales represented more than 70% of municipal revenues.
For several years, the Chinese authorities have tried to curb debt growth, fearing its consequences on the stability of the financial system. With previous sources of funding becoming increasingly restricted, real estate development companies have become increasingly dependent on pre-sale income where buyers have paid for their apartments, sometimes in full, months or even years before the start of the sale. ‘completion.
According to calculations by the French bank Natixis, cited in the article, “between 2015 and July 2021, the share of pre-sale funds as a source of financing for developers increased from 39% to 54%. In the case of Evergrande, thousands of buyers have paid large sums of money to find out that the apartment they bought may not be finished, a situation which has led to protests in front of the houses. Evergrande offices.
Other comments on the Evergrande crisis have highlighted its implications for the economy as a whole. A recent article in the Financial Time described it as the end of China’s “build, build, build model” and said there were enough empty properties in China to house more than 90 million people.
Due to their close link with the real estate market, a financial crisis is brewing for local communities.
This week, Bloomberg reported that, according to economists at Goldman Sachs, hidden local government debt has reached an amount equivalent to more than half of China’s GDP.
The report states that the total debt of local government financing vehicles reached about 53 trillion yuan ($ 82 trillion) at the end of last year, up from 16 trillion yuan in 2013. This equates to 52% of GDP and more outstanding public debt.
Feverish real estate development and the accumulation of debt created the conditions for a major financial crisis. Their dismantling will also stimulate explosive social struggles of the working class against the regime of the Chinese Communist Party.