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Global markets are jittery over the possibility that problems at Evergrande, the world’s most indebted property company, could become a “Lehman moment” for China — with knock-on effects for the world. Risks to the international financial system are, in reality, far less than those that stemmed from the collapse of the US investment bank 13 years ago. Yet the repercussions of the Evergrande affair could slow China’s rapid growth rate considerably.
The context of the Evergrande crisis is entirely different from Lehman Bros in 2008. Most obviously, Lehman operated in a free market; Evergrande does not. Lehman’s fate was sealed when banks would no longer lend to it. The bulk of Evergrande’s liabilities are with domestic financial institutions, though foreign funds are understood to have bought its offshore US dollar bonds. China’s almost entirely state-owned banking sector will withhold credit from Evergrande for only so long as Beijing wishes.
So while Evergrande’s US dollar bonds are trading at levels that suggest default, Beijing is unlikely to allow the company’s woes to proliferate to the point at which they risk creating a systemic crisis. The correct way to view the Evergrande meltdown is to see it as a controlled explosion.
Beijing is teaching the developer a very public and painful lesson. It aims to impress on the hundreds of companies in China’s property sector that it is serious about the “three red lines” it announced last year. These restrictions on debt levels that developers can carry on their balance sheets are intended to avert a crisis, not create one.
The risks that flow from the Evergrande crisis are nonetheless real and varied, and revolve around Chinese growth. Real estate, broadly defined, is estimated to contribute about 29 per cent to China’s annual output. A vibrant market also allows local governments to sell land to developers, generating about one-third of their revenues and allowing them to issue “local government financing vehicle” bonds.
The proceeds from such bonds drive the national obsession with infrastructure and other fixed asset investments, which contribute a further large portion of growth. So if property sales slow — as they are now doing — and touch off a collapse in land sales, local governments will have less wherewithal to raise finance for infrastructure.
China rightly wishes to wean itself off growth led by property and fixed asset investments. But in the short term, the risk of international contagion is palpable. Iron ore prices are down by 60 per cent since a record high in May and copper prices have also taken a hit as traders fret over waning demand for raw materials used in construction. Economists are starting to revise down forecasts for full-year Chinese growth and face the possibility that its economy could suffer in the longer term.
But the immediate danger for financial markets — and for China itself — is overkill. If, in their zeal to teach Evergrande a lesson, officials slash domestic property sales and prevent hundreds of developers from accessing the financing they desperately need, then pressures in the offshore US dollar bond market could turn into a rout. Housing starts in China could also fall to anaemic levels, further depressing global commodity markets.
Xi Jinping, China’s authoritarian leader, is clearly a supporter of the property crackdown, saying in 2017 that “houses are for living in, not for speculation”. But he and China should tread carefully as they bring real estate developers down to size. Too much, too fast could provoke an abrupt slowdown in Chinese growth — with global consequences.