If you’ve been following the economic news of the last couple of weeks you’ve undoubtedly heard of the Chinese property developer called Evergrande. It is the second-largest property developer in China, with nearly 300 billion dollars of debt, and many fear it is on the brink of collapse. It’s stock price has fallen by over 80% this year which led investors, creditors, and material suppliers to protest outside their headquarters in Shenzhen to demand their money.
While most people are aware of the massive economic gains China has made over the last 40 years, fewer know just how dependent this growth has been on construction, specifically housing construction. Because of regulations by the Chinese Communist Party most people in China tend to view the Chinese stock market as a casino. This has led to a major shortage of investment opportunities for the growing Chinese middle class. In response, homeownership is considered one of the only secure forms of investment in China. The significance of homeownership in China becomes obvious when you compare its 90% homeownership rate with the United States’ 65%. This translates to real estate construction making up 15%-20% of China’s GDP.
This kind of system has created a constant demand for housing, which along with the ever-increasing real estate prices, has historically been incredibly profitable for developers like Evergrande. During this rapid expansion, Evergrande was able to purchase a diverse assortment of assets including an electric car company, a soccer club, and even a mineral water business. However, this profitability was dependent on two main factors, the continued increase in real estate prices and the easy access to capital. While real estate prices remain relatively high the same can not be said for liquidity as the CCP tries to reign in the massive debt bubble that appears to be forming in China. Evergrande has become so cash-strapped that they have tried paying back investors and employees with real estate properties. This credit crunch is made even worse when you consider the fact Evergrande has taken deposits for over 1.4 million homes that it has yet to build. With Evergrande’s debt problems many believe these homes will never be completed.
Whether Evergrande collapses or is given a lifeline and allowed to restructure completely depends on what the CCP prioritizes. While many people might assume ensuring confidence in the Chinese market might be their top priority the CCP has recently been trying to prove it can get a handle on its debt as well as clip the wings of the billionaire class in China. This new instinct was most recently observed when Alibaba founder, Jack Ma, disappeared for several months after criticizing the government’s regulatory bureaucracy. When he reappeared, his attitude had changed dramatically, opting for a much lower profile.
It is unlikely that the CCP will want to deal with the fallout from a complete default of Evergrande, the company employs 300,000 people directly and over 2 million indirectly, but the CCP clearly wishes to make an example of this. Without a doubt, the foreign bondholders will be hung out to dry, and it would be little surprise if the richest Chinese investors also take a massive hit. However, at the end of the day what happens with Evergrande will probably mean far less for the world economy than the collapse of Lehman Brothers did in 2008. The debt held by Lehman Brothers was nearly double that held by Evergrande and the U.S. economy was far more interconnected to the rest of the world than the Chinese economy currently is. Keeping this in mind, even if Evergrande was to experience a Lehman Brothers type collapse, the ramification for the rest of the world economy would likely be far more manageable. If the CCP manages to effectively contain Evergrande’s debt problems what it will most likely symbolize is the moderation of the debt-fueled growth China has experienced in the last couple of decades. If this happens to be the case it’s possible we may begin to see Chinese growth rates align closer to that of the developed world.