Evergrande Group and China's leaders
This is no time for a major financial event, but can they stop it?
The real estate giant China Evergrande Group has dominated the financial headlines, and for a good reason. Evergrande is massive. At the end of June, its interest-bearing debt was $88.2 billion, while its liabilities totaled $351 billion from which 10.5% were owed to 45 property developers.
As she stands, Evergrande easily creates a systemic risk, and that’s why Beijing is likely to take action. The company has hired Houlihan Lokey and Admiralty Harbour Capital, a respected investment bank and a credit-specialist, which have been interpreted as a preparation for a (major) debt-restructuring. Like insigthfully noted by John Authers from Bloomberg, Evergrande looks more like a Long Term Capital Management -moment (debt restructuring/partial bailout) than a Lehman -moment (no bailout/collapse), but there naturally are no effectual guarantees.
I also consider it to be unlikely that Beijing would allow the Chinese economy to blow up at this point. Leaders of the Communist Party will gather in November to prepare for the leadership reshuffle in the national congress next year. It’s very unlikely that Xi Ping will let the economy implode before the conference and put his leadership in question.
However, at the same time, President Xi will need to show that he is in control of the economy. Leaders of China’s Communist Party are likely to be acutely aware of the debt bubble (or a debt monster), their party has created over the past 12 years, detailed in my previous post. This is why an outright bailout of Evergrande looks unlikely and a debt restructuring, and possibly chopping the real estate giant to smaller pieces sold to other private or state-owned companies, likely.
Moreover, woes of Evergrande are related to the deleveraging efforts of Beijing, which have already wreaked havoc in the economy. For example, in August new home sales fell by 24% (year-over-year) and land sales by whopping 53%! Around 30% of GDP of China is attributable to real estate sectore. This means that Evergrande is only the beginning.
Previously at this point, Beijing has always turned the “credit levers” back up (see, e.g., our blog from October 2017), and allowed the massive leveraging to continue. Now, the questions are, will they and will it help?
For the former, it’s advisable to keep a close eye on the price of copper (and also iron ore). Few years back our analysis revealed that it has been a trustworthy “real-time” indicator of leveraging/deleveraging in the Chinese economy. Now, lockdowns, reopenings and massive stimulus around the global have messed up its signals a bit, but any drastic trending upward movements in its price (probably that of iron ore) are still a likely telltale that Beijing has pushed ‘credit levers’ back up.
For the latter, the answer is more tricky. We’ll try to discover something of an answer in the September issue of our Q-Review series published next week.