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A Hong Kong court’s order Monday to liquidate China Evergrande, once the world’s most valuable real estate company, serves as a warning to investors, other indebted companies and China’s leaders.
In the immediate term, the liquidation process is expected to highlight the weak legal protection afforded to offshore investors in Chinese assets. A series of competing international and domestic claims over Evergrande’s assets is disrupting the restructuring of a company with more than $300 billion in liabilities. If – as expected – domestic demands prevail, investor confidence in Chinese assets traded in Hong Kong could be further shaken.
More broadly, this constitutes a test of Hong Kong’s authority with mainland China. It is unclear to what extent – if at all – local government entities, courts and mainland creditors will accept Hong Kong’s orders to transfer the assets they currently own to a liquidator.
Nationally, the implications are even more fundamental. The bursting of the Chinese real estate bubble, combined with deteriorating demographics and enormous debt overhang, raises the specter of “Japanization”, in which the world’s second-largest economy could sink into the type of low-growth malaise that experienced Japan in the 1990s.
The disappearance of Evergrande is already part of a long saga. The company, which in addition to real estate has a range of interests in sports, entertainment, finance, healthcare, automobiles and agriculture, began its descent into insolvency after missing payments on coupons on offshore bonds at the end of 2021.
Since then, its shares have lost almost all of their value and its outstanding dollar bonds are trading at extremely distressed levels, with one bond maturing in 2025 at less than two cents on the dollar. Hui Ka Yan, its president, was placed under “compulsory measures” on suspicion of “illegal crimes,” authorities said.
A significant risk now is that the Evergrande crisis – which has already dampened China’s overall economic growth – will continue to have knock-on effects. One is that listed Chinese developers on the mainland and abroad may lack the cash to deliver at least some of their unfinished housing, which Gavekal Dragonomics, a consultancy, has rated at 7, 5 billion RMB ($1 trillion). Another risk is that promoters, in financial difficulty, will not be able to pay their suppliers. Again, the numbers are huge: listed developers collectively owed RMB 3.4 billion in debt to their suppliers as of mid-2023, according to Gavekal.
The scale of these figures suggests an uncomfortable truth for Beijing. In many respects, China’s weaknesses appear more pronounced than those of Japan some thirty years ago. The vacancy rate for urban residential properties is around 20 percent in China, more than double the 9 percent recorded in Japan in 1990, according to a Goldman Sachs study. Property prices are around 20 times higher than household income, compared to 11 times in Japan in 1990, Goldman Sachs added.
The big unanswered question facing these dire scenarios is: how much does Xi Jinping, the country’s strongman, actually care? Beijing is expected to use its central government’s healthy balance sheet to boost the broader economy. This should accelerate the restructuring of property developers and financing vehicles for local authorities in difficulty. More than anything, Chinese authorities must learn from Japan’s mistakes and move quickly to sell off depreciating assets, making necessary cuts along the way. But it is far from clear that Xi is as focused on promoting economic growth as he is on ensuring China’s security and technological progress.