Analysis: For Xi and China Evergrande, a delicate balancing act

SHANGHAI, Sept. 24 (Reuters) – The crisis at real estate giant China Evergrande Group poses a $ 305 billion conundrum for President Xi Jinping: how to impose financial discipline without fueling social unrest.

A year before the Chinese president is set to secure an unprecedented third five-year term, the stakes are high for what is proving to be the most significant period of his tenure.

Evergrande’s borrowing-to-build model was made possible by a government dependent on property sales for its income and unwilling to bite the bullet on runaway debt lest a collapse in prices would have devastating consequences for a country in which property represents 40% of household wealth. .

Xi, who unleashed a wave of industrial and societal reforms this year in the name of “common prosperity,” made it clear that the excess decades of skyrocketing growth fueled by relentlessly rising house prices and debt must be under control.

But shared responsibility for the Evergrande crisis – and concerns about the repercussions of a disorderly collapse – complicate decisions about the fate of a conglomerate with $ 305 billion in debt that scrambles to pay its creditors, including including bondholders who owed $ 83 million in coupon payment that was due on Thursday.

“The government has, to some extent, caused the problems at Evergrande,” said Andrew Collier, managing director of Orient Capital Research, citing debt-to-debt ratio ceilings, known as the “three red lines,” imposed on developers in 2020 that put Evergrande under significant stress. and forced him to start selling assets.

The caps follow new official concern last year over the foaming real estate sector after monetary easing to cushion the impact of COVID-19 led to increased sales and signs of speculative overbuilding from investors. developers.

But curbing house prices is difficult given the tax dependence on the sector. Local authorities, which according to Orient Capital’s estimates represent 89% of total public expenditure, derived more than 40% of income from the sale of land in 2020, creating a co-dependent relationship with developers.

“(The developers) seem to get caught up in the political economy … which effectively leads to a huge number of bad decisions because you are now making investments based on political whims and political winds, rather than real sense of the game. business, “said Fraser Howie, author of several books on the Chinese financial system.

DEEP ROOTS

The roots of the crisis can be traced back to the tax reforms of 1994, which bolstered central government coffers but left local governments dependent on land finance for their income, said Alfred Wu, associate professor at the Lee Kuan Yew School of Public Policy at Singapore.

This sparked a rise in real estate prices and the growth of developers like Evergrande, who thrived in third and fourth tier cities.

“Evergrande is a cash cow for regional governments. If the company goes bankrupt, the land finance model and regional governments will also go bankrupt. The central government will not allow it,” Wu said.

Despite years of warnings from some about the business model used by Evergrande and others, which included heavy leverage to stimulate land and project acquisitions, the company was hardly a dishonest operator.

Chairman and majority shareholder Hui Ka Yan has been careful to show his close alliance with Beijing and the ruling Communist Party, and has been reciprocated.

A list of Hui’s achievements featured in Evergrande’s 2020 annual report is named a “national model worker,” an award-winning poverty fighter, and “excellent builder for the socialist cause with Chinese characteristics.”

GREAT AWAKENING

Beijing obsessed with stability is well aware that the increase in the housing market has created not only great wealth, but also deep inequalities.

A non-China-based portfolio manager who declined to be identified said the 2019 anti-government protests in Hong Kong, blamed in part on inequality fueled by sky-high housing costs, were a wake-up call for Beijing.

This year, Xi set out to reform the “three huge mountains” of housing, education and health care to curb soaring costs for city dwellers to strengthen legitimacy as the “leader of the people,” they said. analysts said.

Protests from disgruntled vendors, buyers and investors last week illustrated the dissatisfaction that could escalate if default payments trigger crises for other developers. Read more

UBS estimated there were 10 developers with potentially risky positions representing combined contract sales of 1.86 trillion yuan ($ 287.92 billion), nearly three times Evergrande’s total.

Still, many analysts say a wider crisis is unlikely, predicting authorities would choose a path to compress the entire real estate industry while tackling individual issues as they arise.

“The government knows that if it doesn’t handle Evergrande carefully and lets it go bankrupt, disgruntled owners and shareholders could cause social instability, defaults could lead to financial risks, massive layoffs could worsen employee problems. jobs and private companies might be more scared, ”said Tang Renwu, who heads the School of Public Administration at Peking Normal University.

($ 1 = 6.4602 Chinese yuan)

Reporting by Andrew Galbraith in Shanghai Additional reporting by Yew Lun Tian in Beijing Editing by Tony Munroe, Robert Birsel

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