The Evergrande saga is intensifying every day. The company’s equity has practically disappeared. Its debt is barely negotiating. Its sales and assets are plummeting in value. Its brand damage is ruinous:

In addition, we have now reached an open point of crisis for the entire Chinese real estate development sector. It is not possible to distinguish collapses from funding gaps from a freeze. Good and bad equity are evaluated for calamity. Market confidence is gone. Rumors of bailouts and wacky backup plans are rife:

However, the signals from policymakers are calm. The rhetorical umbrella of “common prosperity” that covers a wave of regulatory intervention in China allows Beijing to justify the hammering of rentier billionaires, and no bailout for developers looks imminent.

Indeed, on Friday, the state sponsored World time the chief troll said no support is future:

Editor-in-chief of Chinese state-backed newspaper Global Times warned debt-ridden real estate giant Evergrande Group (3333.HK) it shouldn’t bet on a government bailout on assuming it’s “too big” to go bankrupt ”.

It was the first comment to appear in state-backed media questioning a government bailout for the country’s No.2 property developer, whose shares fell for the fifth day in a row on Friday amid fears that ‘it does not fail.

Evergrande is working to raise funds to pay off its many lenders, suppliers and investors, with regulators warning that its $ 305 billion in liabilities could trigger greater risks to the country’s financial system if not stabilized. Read more

Global Times Editor-in-Chief Hu Xijin said on his WeChat social media account on Thursday that Evergrande should look to the market for salvation, not the government.

The base scenario of the Evergrande crisis has thus shifted to a lasting upheaval for Chinese real estate development. But what variety?

Ruin or reform?

You can hardly be faulted for remembering other financial crises like the Lehman Brothers that sparked the global financial crisis. The underlying imbalance is a huge real estate bubble. The leverage effect is terrifying. Actors are too big to fail and policy makers are stuck between moral hazard and disaster.

Or is it the case? There is another way to look at this latest episode of Chinese reform. This is the fourth installment of Chinese attempts to get rid of its problematic real estate development sector. The first started in 2011. It accelerated again in 2015 and 2019. Each time, the faltering growth that followed frightened policymakers.

China continues to revert to this program for a reason. Its excesses in the real estate market are the main threat to its economic development trajectory. Real estate is both the source of its sustained catch-up growth and its loss if it is allowed to go too far. No other Chinese sector is misallocating capital and killing productivity on such a scale. If not restructured, it will drag China into the middle income trap of low income, stalled growth and declining efficiency.

If so, the key to understanding this crisis is that it is more deliberate than the Lehman Brothers episode. It probably does not threaten the financial system. China owns its banks and can liquidate credit at any time. He could bail out Evergrande and his real estate business tomorrow if he wanted to. It has a lot of monetary space to play with and can, at any time, stimulate more real estate activity by loosening macroprudential controls. It is choosing not to do it.

This does not mean that no financial crisis is coming. He is. But this is not so much for the banks (which will experience turmoil) as for real estate developers in particular.

The implications of this are still very material, and in some ways even more so. A deep Chinese construction recession will significantly affect overall Chinese growth, more than anyone expects in the fourth quarter and into 2022. This is due to two factors:

  • First, the direct impact of reduced construction will be exacerbated by a bad debt shock that will reduce some loans, and falling house prices (in some areas) will dampen consumption.
  • Second, the infrastructure will not rebound out of place as hoped. It is too closely linked to real estate in the balance sheets of local authorities.

Moreover, if economic restructuring is the goal, the recovery will also be different. The stimulus will be slower to come than usual. And when the shakeout is complete, the payback will not be V-shaped. It will be L-shaped as real estate development grows via quality and not quantity from a greatly diminished base.

Lehman or Greece?

If we are looking for a historical analogy to make sense of such an intentional campaign of economic restructuring around the GFC period, then there is another episode to consider. In 2010, Germany took advantage of the post-GFC boom to drag Europe into an episode of deleveraging and structural reforms. The European debt crisis has been allowed by the German authorities to reform double-deficit economies. The “PIIGS” as we knew them.

This crisis could also have been ended at any time. But it was only when the Teutonic states were convinced that the message to stop the waste reached the policymakers of the “PIIGS” that the ECB was allowed to print and restore order to yields.

Likewise, China has built its urban environment enough to support its ongoing population movements of up to 80% urbanization in the 2030s. Doing more will only strangle the economy with unproductive debt. China has only 200 million more people to move and around 60 million empty apartments have already covered them.

The dismantling of Evergrande and its peers can thus be regarded as an admirable enterprise of cleaning up wasted capital; a long delayed but essential step if China wants to get its economy out of the middle income trap through higher value-added growth.

The consequences

Yet for everyone, it’s still the end of China’s biggest catch-up growth phase.

If the baseline scenario of the Chinese reform effort comes to fruition, it bodes well for a global economic adjustment that will encompass everything from crushed commodity prices, to the contested export dependence of emerging markets, to competition with China on value-added production, a deflationary tsunami similar to a global recession and an overvalued developed market asset account.

Policymakers will gradually support in the form of a slow-motion restructuring of Evergrande and other struggling developers without obvious bailouts. Anne Stevenson-Yang summarizes how it will be likely to arrive.

There will be significant RRR and rate cuts in due course, as well as more tax support, but not in real estate.

This implies a big drop for the yuan. This will export a lot of economic pressure on the external balances of emerging markets as commodity prices collapse and their competitiveness with China erodes. If the Fed simultaneously declines and increases pressure on emerging market capital accounts, then an emerging market crisis emerges as the greatest risk of international contagion.

Finally, there are two other risk scenarios to consider, one on the downside and the other on the upside. It is still quite possible that China will lose control of the shakeout. China’s fantastically opaque funding chains could crumble and drag the financial system. Policy error remains the major risk of our time.

If that happens and Chinese house prices follow Evergrande into the abyss, then the global economy could see the end of the post-COVID cycle begin.

Which leaves us with the second case of risk. Let Evergrande panic policymakers with another round of sweeping stimulus packages and we will do it again in 18 months!

Houses and holes
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