Crunch time for Evergrande as payments due for China property giant

A collapse in China’s property market would have a huge impact globally but Australia could well be the “biggest hit”.

ANALYSIS

Angry Chinese homebuyers are storming office blocks chanting, “Give us our money back.” Contractors are getting paid in IOUs. Billionaires are facing Communist Party pressure to pay up.

The Evergrande crisis is getting real.

It’s crunch time for China’s biggest property development group. Another debt payment deadline has fallen due. Whether or not it makes the $A60 million payment could determine the fate of the national real estate market. And that represents a quarter of China’s total GDP.

S&P Global Ratings warns that up to one-third of all China’s property developers face “acutely strained” financial conditions. And that puts them at “real” risk of defaulting on $A111.7 billion worth of debt repayments due next year.

Even China’s state-controlled Global Times news service admits that “more bond defaults likely for Chinese real estate companies”.

But that’s not the real problem.

Of greatest concern is how small investors, contractors and suppliers react. Cash flows will quickly dry up if they batten down the hatches and clamp down tightly on their wallets.

And that has international implications.

Hong Kong-based independent market research analyst Travis Lundy warns the downstream impact on Australia will be substantial.

“Some global players would feel economic pain from a slowdown in China much more than others,” he told the BBC. “I think Malaysia is considered to be the most correlated economy. However, one could easily point to Australia and say that would be the biggest hit.”

A worker walks in front of the under-construction Guangzhou Evergrande football stadium in Guangzhou, China. Picture: Noel Celis/AFP

House of straw

Strict new debt-to-asset limits introduced by Beijing prevent China’s heavily geared property development industry from borrowing fresh money to pay the interest on older debts. And that’s causing a cash crisis for highly exposed firms – such as Evergrande.

“New regulations and weak sentiment are squeezing these capital channels,” an S&P research note reads.

“The idea that entities may be abruptly deprived of such funding, threatening refinancing plans and potentially triggering defaults, is a large part of our scenario analysis.”

Evergrande missed a set of interest payments on its foreign-sourced debts in September and October. However, it made a payment on one of these defaults before a 30-day grace period expired last week. A second repayment grace period expires on Saturday. It must make another three on November 11.

Failing to meet these will trigger a cascade of further defaults. Where it finds the cash to continue to fund its $A400 billion debt remains to be seen. About $A27 billion of that is foreign-sourced.

But Evergrande is just part of Beijing’s financial woes.

Other prominent developers have also defaulted on debt repayments in recent weeks. Fantasia Holdings, Sinic Holdings and Modern Land (China) are the more notable names.

Several more heavily geared developers, including Central China Real Estate and Agile Group, also face hefty bills in the coming months.

It’s all because Chairman Xi Jinping wants change.

Property pandemic

The word on international financial analysts lips is “contagion”.

The International Monetary Fund says Evergrande’s financial risks are “contained”. But, if it defaults on its many upcoming bonds, that may trigger a psychological backlash.

“So the worry really is contagion,” says economics analyst Professor Adam Tooze.

“It’s not so much Evergrande itself is the fear and sort of financial distress that could spread out from that one company and could become a sort of self-sustaining wildfire.”

Potential homebuyers are becoming hesitant, causing sales to fall.

The appearance of IOUs means suppliers are demanding upfront payments.

And each of these, in turn, can cause cascading cashflow problems throughout the economy.

Such fallout is already being factored into the financial markets.

Chinese investment in Australia plummeted 61% in 2020. Some in Australia have been politicizing and stigmatizing normal economic and trade cooperation between #China and #Australia at every turn. This has dampened Chinese companies’ confidence in investing in Australia. pic.twitter.com/GqBOYSvkw2

— Chinese Consulate General in Sydney (@ChinaConSydney) October 28, 2021

S&P Global Ratings warns that it expects apartment and housing sales in China to fall by some 10 per cent next year. And that downturn is likely to be repeated in 2023.

That doesn’t bode well for property developer bottom lines.

The worst-case scenario, S&P says, is that developers may have to suspend construction projects.

“The affected general contractors and suppliers may then stop paying their own suppliers, or stop work for other property developers, causing spillover effects,” it says.

Those spillover effects will inevitably reach Australia, says Mr Lundy.

“A lot of Australia’s GDP is also tied to real estate and producing materials and supplies that end up in China. And if that slows down dramatically, then, you know, Australia will feel it.”

Hui Ka Yan, chairman of China Evergrande Group, is under pressure to keep the company afloat. Picture: Paul Yeung/Bloomberg

From boom to bust

Communist China has enjoyed several decades of relaxed regulation and a “let some get rich first” approach to investment and development. As a result, international commentators have declared the modern Chinese economy to be Communism with Capitalist characteristics, or Communism 2.0.

In 1998, Chinese citizens under the Communist regime were allowed to own private property for the first time. That triggered an immense property boom, especially among those surging into new industrial centres and coastal cities.

And as the rapidly expanding Chinese middle class had little else to invest in, real estate was the obvious choice. Evergrande alone is committed to some 1300 large-scale property developments in 280 cities across China. Some 1.4 million prospective homeowners have made hefty down-payments on unfinished apartments.

About 80 per cent of Chinese household wealth is in property. For Australians, that figure is about 39 per cent.

“So, essentially, all of China’s growth miracle – at least 20 per cent, perhaps more of the entire growth story in recent years – is this real estate drive,” Professor Tooze says.

In all, property investment represents some 25 to 30 per cent of China’s GDP. In Australia, it’s about 5.8 per cent.

Beijing, however, is pressing on with its economic reform. It argues it’s better to confront these issues in a “controlled demolition” now rather than leave them to blow up later. And it’s prepared to accept an economic slowdown will be part of this process.

“I think the betting is that the regime will try and ensure that small savers, the people who put down deposits, get paid,” Professor Tooze says. “That’s because the regime is deeply interested in social stability. You’d have to figure that the foreign lenders, the people who were brave enough to put money in, that they’ll be last in the queue.”

Capitalism, with Chinese characteristics

Last year, Chairman Xi introduced a new set of rules for China’s real estate industry. Known as “The Three Red Lines”, it defined strict borrowing limits to try to rein in the sector’s burgeoning debt. Liabilities must not outstrip assets. Loans must not be greater than the value of ordinary shares. And they must have more liquid cash than short-term debt.

But that’s not all.

Chairman Xi’s new “Common Prosperity” edict has suddenly imposed new costs, such as mandatory pay rises. The tech industry is facing new privacy and censorship controls. The entire education tutorship system has been shut down, costing hundreds of thousands of jobs. Gamers under 18 are limited to one hour online on Friday, weekends and holidays.

It’s all intended to make life easier and fairer for families.

Chinese President Xi Jinping has introduced a ‘Common Prosperity’ edict which has affected tech and education industries. Picture: Noel Celis/AFP

But the beneficiaries of the old “let some get rich first” policy must change with the times.

It’s a delicate balance.

The problem is, about 25 per cent of all new apartments in China are empty.

The investor-driven construction boom has far outstripped residential demand.

And that means those investments are making no return.

It’s dead money.

And the majority of struggling investors are families.

Meanwhile, the Communist Party is strictly controlling the messaging delivered to its unsettled citizens. Its elite officials are in control. The infallibility of the Party is assured. Destiny is on China’s side. The greatest priority will be assigned to the wellbeing of the people.

The future of Chairman Xi and his authoritarian-Communist state may depend on this being true.

Jamie Seidel is a freelance writer | @JamieSeidel