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What's the Chinese for "Lehman"?

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Well, there's no exact translation, but perhaps a close equivalent might be "Evergrande". Just as Lehman Brothers was, at one time, seen as the corporate symbol of the never ending boom of globalisation, so Evergrande, a property developer rather than a bank, was, at one time, seen as the corporate symbol of the ever-growing wealth of China since the restoration of capitalism.

And, like Lehman Brothers, the symbolism has proved to be based on mountains of debt that cannot be repaid. Within the next two years, Evergrande should repay foreign bonds worth some $11.9 billion. On September 23, the company was due to pay $83.5 million in interest on one bond, no payment was made. On September 29, a further $45.2 million on another bond was due, that was not paid. As a result, Evergrande is now in a 30 day "grace period" before it is declared to have defaulted.

Even worse are the debts to Chinese creditors, they are estimated at $310 billion. They used to say that, if you owed a bank $1 million, you had a big problem but, if you owed a bank $100 million then the bank had a big problem - and $350 billion....?

Implications

The importance of Evergrande is not just that it is a huge corporation that is likely to go bust. It is far from the only property developer facing the same problem. Last year, Country Garden Holdings had the highest sales in the sector, its liability to asset ratio is 78.5 percent, well above the government's limit. According to Morgan Stanley, the property sector as a whole has debts amounting to $2.8 trillion and accounts for some 30 percent of GDP. Nonetheless, the implications of Evergrande's possible collapse go deeper than even these figures suggest.

In many ways, the company is a product of China's entire economic model ever since the restoration of capitalism. It was founded by Hui Ka Yan, an engineering worker, in 1996 to take advantage of new opportunities opened by the dismantling of the planned economy. Previously, local government spending was based on centrally allocated grants, once these were ended, local authorities began to raise money by sales of land to property developers.

Given the scale of urbanisation, as hundreds of millions flocked into fast growing cities, borrowing money to buy land on which to build both industry and housing was not only lucrative but also politically advantageous. Relations between local government, property developers and local, state-owned, banks blossomed, and contracts were, of course, overseen by the local officials of the Communist Party. What could possibly go wrong?

For twenty years, as far as Hui was concerned, nothing went wrong. Indeed, after the financial crisis of 2008/9, when China launched its huge spending programme, things could hardly have gone better. By 2015 his fortune was estimated at $45 billion and he was feted by the great and the powerful. That year he accompanied Xi Jinping himself on his trip to London, where he was entertained by Prince Andrew at Buckingham Palace - although perhaps he would not now draw attention to that particular liaison.

Ironically, it was also in 2015 that the way things could go wrong first became apparent. A collapse in the Shanghai stock market revealed the gulf between its valuation of many companies and their actual assets. (For more on that see: https://fifthinternational.org/content/china-free-market-not-going-accor...) The government's immediate response, basically freezing all activity on the markets, re-established stability quite quickly but, after that, rules were introduced to limit the growth of debts, particularly through state banks.

This had an immediate impact on the property developers' business model, they could no longer rely on easy credit from state banks eager to finance "growth" irrespective of financial viability. Instead, Hui, and others like him, true to their optimistic motto, "Build it and they will come" began to raise capital for their developments by selling "off the plan", that is, selling properties before they were built. According to a report from the French bank, Natixis, such funding now accounts for 54 percent of property development.

Red lines

In July of last year, the government brought in still tighter regulations, referred to as the "three red lines", to bear down on real estate speculation. The "lines" refer to the limits imposed on three key metrics, the ratio of liabilities to assets, net debt to equity, and cash to short term borrowings. 14 of China's 30 biggest property developers have breached at least one of these red lines in recent months.

Such breaches have revealed that the entire sector is on the brink of crisis. On the one hand, in some regions, despite that motto, they did not come, there are currently some 30 million empty flats in China. On the other, shortage of funding has meant that properties paid for in advance have not actually been built. Evergrande is estimated not to have delivered 1.6 million properties.

Interviewed by the Financial Times, Jim Chanos, whose claim to fame is that he predicted the collapse of Enron, observed, "In many ways you don't have to worry that it's a Lehman type situation but in many others it's far worse because it's symptomatic of the whole economic model and the debt that's behind the economic model. All the developers look like this. The whole Chinese property market is on stilts.”

There is the dilemma for the Beijing government; almost a third of the domestic economy is not financially viable. This is not a question of whether to hang Hui Ka Yan out to dry, it is about entire industries, trillions of dollars' worth of assets and it is about 1.6 million families who thought they had bought a home.

How Beijing handles this is still to be seen. The "grace period" ends on October 23, after that, if the interest payments are not made and Evergrande is declared in default, creditors are entitled to seize assets. Before that, it is likely that the state will enforce measures to sell off assets, restructure debts and possibly break up the conglomerate into separate divisions, the better to identify any viable sections. In all probability, the state will guarantee completion of already sold projects, to ensure social stability. It has already introduced industry-wide rules requiring all receipts from "pre-sales" to be banked separately under local bank supervision.

Contagion

While such emergency measures may limit the immediate fall-out from the collapse of Evergrande, it cannot but have a dramatic impact on the whole property development sector, as we have seen, other companies are also facing default. Since their bonds are held by other companies which can use them as collateral for their own borrowing, there is a serious risk of "contagion" spreading beyond the defaulters. Certainly, many creditors are going to have to "take a haircut" by accepting only a percentage of their due repayments. Foreign investors in particular will be unlikely to extend any further credits to developers in China.

Even if such measures are enough to prevent a widespread collapse across the whole sector, which is not guaranteed, the debt crisis is bound to have a powerful impact on the economy more generally. Quite apart from the immediate consequences of uncompleted projects, this puts in question the policy that has been central to China's economic growth, particularly since the crisis of 2008/9, investment in infrastructure and construction.

Many economists have argued that such a change is necessary, calling for priority to shift towards domestic consumption to "rebalance" the economy. However, even if Xi and the party leadership agree with that, there have to be many vested interests that will oppose it. That poses a fundamental problem for the whole political regime.

Xi himself only became president after a protracted factional battle within the CCP (see for our examination of that) and in his first term consolidated his faction's position by a purge of opponents, prioritising the "left" of the party who opposed further erosion of state control and concessions to the private sector.

In his second term, since 2017, and in the wake of the financial crisis of 2015, there have been, by contrast, several high profile actions against some of the richest capitalists in China. For example, just days before the Initial Public Offering of Jack Ma's Ant Group on the Shenzhen stock exchange, which was expected to be the highest IPO valuation ever, anywhere in the world, the listing was halted by the state. Ma, himself a member of the CCP as well as a billionaire, was not seen for months but has since accepted the decision.

Party discipline is no doubt a powerful factor, and repression can also be very effective, but the after-effects of the property crash and the prospect of a major change of economic policy must have consequences within the party. Old factions will feel justified, new factions will form. It cannot be otherwise because the party itself has encouraged "businessmen" to join and, after 30 years of building capitalism, many state officials, the backbone of the party, are themselves locked into further capitalist development.

It is these tensions and contradictions that lie behind the increasingly authoritarian regime in China; the enhanced population control through surveillance programmes, the genocidal repression of the Uighurs of Xinjiang, the exaggerated crackdown on democratic rights in Hong Kong, the belligerent assertion that Taiwan must return to Chinese sovereignty. These are not explained by the personal psychology of Xi Jinping, as they are often presented, they are a preparation for stormy times ahead.

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