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A Hong Kong court’s order Monday to liquidate China Evergrande, once the world’s most valuable real estate company, is a warning to investors, other debt-laden companies and China’s own leaders.
The liquidation process will soon highlight the tenuous legal protection afforded to offshore investors in Chinese assets. Numerous competing domestic and international claims on Evergrande’s assets have plagued the restructuring of a company with more than $300 billion in debt. If domestic claims take precedence as expected, it could further erode investor confidence in trading Chinese assets in Hong Kong.
More broadly, it will test Hong Kong’s authority vis-à-vis mainland China. It is unclear to what extent, if at all, local governments, courts and creditors across the mainland will agree to an order from Hong Kong to transfer assets they currently own to liquidators.
At a national scale, the impact is even more fundamental. The bursting of China’s real estate bubble, in addition to deteriorating demographics and a massive debt surplus, is raising concerns about “Japanification,” with the world’s second-largest economy facing a similar situation to Japan’s in the 1990s. There is a possibility that Japan will fall into a slump with low growth.
Evergrande’s demise has already been positioned as a long-term story. The company, which has a range of interests in sports, entertainment, finance, health, automobiles and agriculture in addition to real estate, began sliding into bankruptcy in late 2021 after failing to make coupon payments on its offshore bonds.
Since then, the company’s stock has lost nearly all its value, and its outstanding dollar bonds are trading at highly distressed levels, with bonds due 2025 priced at less than 2 cents on the dollar. Authorities announced that the committee’s chairman, Hui Kar Yan, had been placed under “coercive measures” on suspicion of “illegal crimes.”
The key risk now is that the pervasive crisis, which is already a drag on China’s overall economic growth, will continue to have ripple effects. For one, Chinese developers, listed both on the mainland and abroad, have at least one unfinished housing unit valued at 7.5 trillion yuan ($1 trillion) by consultancy Gabekal Dragonomics. There is a possibility that there is insufficient funds to hand over the department. Another risk is that financially strapped developers may be unable to pay their suppliers. Again, the numbers are huge. According to Gavekal, as of mid-2023, listed developers owe suppliers a total of RMB 3.4 trillion in unpaid amounts.
The magnitude of these numbers suggests an uncomfortable truth for the Chinese government. By some measures, China’s weaknesses appear to be more pronounced than Japan’s were some 30 years ago. According to a study by Goldman Sachs, China’s urban housing vacancy rate is about 20%, more than double Japan’s 9% in 1990. According to Goldman Sachs, home prices are about 20 times household income, compared to 11 times in Japan in 1990.
The big unanswered question in the face of these dire scenarios is how much China’s powerful leader, Xi Jinping, cares. The Chinese government should leverage its strong central government balance sheet to stimulate the overall economy. We need to accelerate the restructuring of financing options for troubled real estate developers and local governments. Above all, Chinese officials need to learn from Japan’s mistakes and act quickly to sell impaired assets while taking the necessary steps. But it is unclear whether Mr. Xi is as focused on promoting economic growth as he is on ensuring China’s security and technological progress.