Evergrande can’t pay its debts and China struggles to contain the consequences

Hong Kong (CNN Business) – Evergrande defaulted on its debt. Now Beijing is stepping in to prevent a disorderly collapse of the indebted real estate group that could wreak havoc on the world’s second-largest economy.

Fitch Ratings said Thursday that the embattled real estate developer has entered “restricted default,” reflecting the inability of the company to pay interest matured earlier this week on two dollar bonds. Payments were due a month ago and grace periods expired on Monday.

Evergrande’s apparent inability to pay those interest reignited fears about the future of the company, which is reeling under a total liability of more than $ 300 billion. Evergrande is a huge company: it has about 200,000 employees, had a turnover of more than US $ 110,000 million last year and has more than 1,300 promotions in more than 280 cities, according to the company itself.

Analysts have long been concerned that a collapse could unleash broader risks for the Chinese housing market, hurting homeowners and the broader financial system. The real estate sector and related industries represent up to 30% of GDP.

Until now, the Chinese authorities downplayed the possibility of contagion risks.

“Chinese leaders are trying to remain calm, but the circumstances surrounding Evergrande’s downward spiral raise serious questions about Xi Jinping’s management of the rapidly cooling Chinese economy,” said Craig Singleton, Deputy Fellow of the Evergrande Program. China at the Foundation for the Defense of Democracies, a Washington-based research institute.

There are already many signs that Beijing is taking a leadership role in guiding Evergrande in restructuring its debt and extensive business operations.

The local government of Guangdong province, where Evergrande is based, said late last week that it would send officials to the company to oversee risk management, strengthen internal controls and keep operations normal.

And earlier this week, Evergrande announced that it would create a risk management committee, with government representatives, to focus on “mitigating and eliminating” future risks. Its members include senior officials from Guangdong’s major state-owned companies, as well as an executive from a major central government-owned debt servicer.

The Chinese authorities also took other measures. The central bank announced Monday that it would inject $ 188 billion into the economy, ostensibly to offset the slump in the real estate sector.

These latest interventions by both the central government and Guangdong officials suggest that Chinese officials now grudgingly accept that Evergrande is, in fact, “too big to fail,” Singleton said.

Global Investors May Lower Evergrande Asset Values

The huge restructuring is going to bring some pain, at least for global bondholders. Beijing made it clear that its priority is to protect the thousands of Chinese who bought unfinished apartments, along with construction workers, suppliers and small investors.

You also want to limit the risk of other real estate companies going under. Investor fears of Evergrande’s bankruptcy pushed up financing costs for other developers, as yields on Chinese corporate debt abroad increased.

At the same time, the government has been trying to curb the promoters’ excessive indebtedness for more than a year, so it will not want to dilute that message.

This means that the government can “be happy to see the company itself go under and investors reduce the declared value of assets,” Louis Kuijs, head of Asia economics at Oxford Economics, said in a research note on Friday.

Chinese regulators blamed the Evergrande crisis on company leaders. Its problems were the result of “mismanagement and blind expansion,” the central bank and the country’s securities regulator said in public statements on Monday, reiterating previous criticisms.

Yi’s comments Thursday, made during a video speech at a forum in Hong Kong, underscore the government’s priorities. He noted that Evergrande’s problems would be handled in a “market-oriented manner.”

This “reinforces the authorities’ current stance not to resort to any bailouts,” said Yeap Jun Rong, market strategist at IG Group.

Effects on the growth of the Chinese economy

Allowing Evergrande’s bankruptcy and minimizing the economic or financial impact is a “delicate balancing act,” said Kujis, especially given the general deterioration of the real estate sector, which has already led to the bankruptcy of other developers, such as Kaisa Group this week. .

New home prices in China fell in October for the second month in a row, according to figures from the National Bureau of Statistics. The September drop was the first in six years on a month-on-month basis.

A major real estate slowdown, along with other factors, could drag Chinese GDP growth next year to 4.3%, according to Ting Lu, Nomura’s chief economist for China. This figure is well below the growth estimated by the company for 2021, which is 7.8%.

During an online conference on Friday, Lu also warned that the government should not suddenly reverse its restrictions on real estate financing. Such a change would hurt Beijing’s long-term goals, he added, noting its desire to reduce the economy’s dependence on property and divert resources from property to other sectors, such as technology.

Kuijs of Oxford Economics expects Beijing to adopt specific policy measures for homeowners, troubled developers or banks exposed to debt risks. He suggested that these measures could include facilitating the raising of funds in the capital market by developers, adjusting land policies and increasing the construction of rental units.

“We also expect further relaxation of fiscal and monetary policy,” he said. “And the government is likely to take steps to contain spillover effects in the financial system, including the possibility of shielding banks especially exposed to troubled developers.”

However, Singleton warned that the real estate crisis remains an imminent threat to China.

“The possibility of contagion in other parts of the vast Chinese economy remains very real,” he said. “And this is where China’s central bank faces its greatest limitation: while it may contain the financial implications of a housing default, it cannot offset the impact of the housing market on China’s real economy.”