As China’s President Xi Jinping seeks to impose a stronger centralised orthodoxy of Marxist “fair shares” he wishes to scythe the tall poppies of the private sector. He seeks to remove the power and fortunes of the successful from the recent years of faster growth, which was enabled by tolerating a lively private sector and plenty of property speculation.
Property ownership has become the biggest way that Chinese can own and hold wealth. They benefitted from rising house and flat values. The richer people bought more than one property or traded up to dearer and more glamorous locations as they accumulated more.
Credit-excess fuelled the boom
Private-sector companies led by the huge Evergrande developed and built more homes and more luxurious properties. They often sold them off-plan, collecting money from customers before there was a property for them to acquire. They went into the savings business, acting as savings banks and promoting property-based investments for some of the money they collected. All of this rested on substantial credit for the fast-growing companies, which borrowed from bond markets and local banks, as well as using client money paid in advance for properties to be built.
Beijing and the central bank want to deflate the bubble and are happy to see the rich entrepreneurs take a hit.
The government decision to stop the excesses of credit and savings banking in this sector has created a series of problems. The fast-growing companies have run out of ways of financing the present by mortgaging the future more – and are now finding it difficult to meet their interest payments. People who have bought properties off plan are awaiting delivery, with the companies stretched to find the cash to employ the builders and finish the works. Some of the investments are being undermined by falling prices of the underlying properties, and of the shares and bonds involved in financing the sector. There are plenty of pre-conditions for a crash.
Beijing and the central bank want to deflate the bubble and are happy to see the rich entrepreneurs and some of their very rich clients take a hit. They do not want to create a property-led crash, they do not wish to undermine the domestic banking system and do not want smaller savers to lose all their money or the property they thought they had bought.
No property bailout
The strategy of the authorities so far seems to be to keep sufficient liquidity in the banking system to avoid a banking meltdown, but not to inject large sums to inflate the property bubble further. This is a difficult set of judgements to make, leading to an erratic money policy on a day-to-day basis.
The Peoples Bank of China has blamed the Evergrande problems on mismanagement and break-neck expansion by the company. The China Banking and Insurance Regulatory Commission has backed up the central bank in demands that Evergrande resolve its debts in a legal and fair way.
- $300bn Evergrande's total debts
The government generally wishes more to be done through state-owned enterprises and less through private-sector companies. Evergrande’s debt problems are now being handled by a committee which includes representation of the regional government.
The attempts to remodel the company may include transfer of assets and building projects to state-owned companies. It may also include accepting write-offs and losses on foreign debt. Evergrande has total debts of $300bn outstanding that it finds increasingly difficult to service, let alone repay. Other property companies including Kaisa, with dollar bonds, are also likely to need a restructuring.
We assume the Chinese authorities will do what it takes to avoid a domestic banking crash and to ensure legitimate housing demand is met with supply. The dollar bond market will be affected, with many of the Chinese bonds already trading at low levels to reflect the obvious dangers. If the Chinese state is not successful in containing the damage it will affect markets beyond Hong Kong and China – and will dampen demand worldwide for the commodities and products needed for building. Even given success in their own terms it will reduce housing output and demand in China which has had knock on effects to commodities and goods needed in building.
An expensive lesson in risk management for foreign bondholders.
The Politburo, mindful of the importance of housing activity to the general economy, is seeking to ease some curbs on real estate and will be promoting more lower priced housing. They urge the honouring of obligations to Chinese individuals who have paid for a home that has not yet been built. The recent cut in the level of reserves banks need for any given quantity of lending is designed to offset some of the contraction caused by the financial difficulties of several leading property companies that provide substantial work to the building industry.
So far, the Chinese state is finding a way through the need to avoid a collapse and the wish to rein in credit and speculative excess in property. Success will entail more transfers of activity to the state and an expensive lesson in risk management for foreign bondholders.
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