Big news in recent Chinese media headlines is an “SOS letter” being circulated online, allegedly written by the Chinese real estate giant Evergrande Group to the Chinese government to plead for support.
Chinese media titled the news as “Evergrande’s SOS Shaking Real Estate Industry: Save Me or I’ll Show You How I Die.” As of now, all related reports have been removed from the Chinese internet except some images.
I’m not interested in the letter’s authenticity (though I tend to believe it’s real), nor whether Evergrande colluded with the government (China’s government-business ecosystem makes it impossible for a business to succeed without hanging itself on the belt of powerful government officials), nor whether it’s ethical for a pet business to threaten its master government. What I am interested in is the content of the report, and why Evergrande believes this is an Achilles heel for the Chinese Communist Party (CCP).
The CCP’s Achilles Heel
The alleged Evergrande Group report warns that if a reorganization of its subsidiary Hengda Real Estate doesn’t happen in time, the company will face imminent dangers. One threat is a cash crunch that may cause default on the company’s 130 billion yuan ($19 billion) debt. Secondly, the Evergrande Group may default on its 835.5 billion yuan ($123.8 billion) debt that involves 171 financial organizations including banks, trusts and funds. The massive cross-default will lead to systematic financial turmoil. Thirdly, 8,441 upstream and downstream businesses will be impacted, and some may go into bankruptcy, which in turn will undermine the nation’s economic stability. And lastly, Evergrande’s 792 ongoing real estate projects will be impacted, threatening 3 million jobs and 2 million homeowners.
The consequences sound serious as they undermine the “six stabilities” and “six protections” national policy that the Chinese central government has implemented for more than three years. They represent the stabilities in the areas of employment, finance, foreign investment, foreign trade, domestic investment, and market expectations (development targets). The “six protections” policy is a reinforced version of the “six stabilities” raised in the 2018 “Two Sessions.” The policy protects the citizens’ employment and livelihood, and core market in order to ensure adequate income and promote consumption and demand. This is the bottom line for a stable economy.
Evergrande must have studied central government documents quite well that they know the CCP understands that the collapse of a large business would be detrimental for the core market, causing defaults and unemployment. Unemployment would then lead to reduced consumption and inability to expand demand.
The “consumption bottleneck” will surely clog the ecosystem and cause the downfall of businesses, employees, and lenders related to Evergrande. Of course, taxes will be greatly impacted, and the “six stabilities” will become the “six turmoils” that threaten China’s economic foundation.
China keeps a record number of real estate businesses. When real estate was in its heyday, many companies switched to property development. In 2018, more than 97,000 real estate developers were registered, though bankruptcy happened every year. More than 2,000 developers filed for bankruptcy in 2014. In the Chinese media’s words, “The pigs who rode on the wind and few fell the hardest when the wind stopped.” The media referred to the fluctuation as a great reshuffling of the real estate industry.
According to statistics, the Chinese regime issued real estate regulation policies 620 times in 2019, a historical record, and a 38 percent increase from 2018.
Regulations tightened financing policies as the China Banking and Insurance Regulatory Commission repeatedly warned about the risk of real estate financing. More and more limitations were applied to sources such as trusts, bank loans, corporate bonds, and overseas debt, which caused cash crunches for some small and medium real estate businesses.
China’s Supreme People’s Court website shows that 2019 was the most challenging year for small and medium real estate businesses, with more than 525 companies filing bankruptcy. Experts pointed out that the bankrupt list includes mostly smaller businesses that were occasionally involved in real estate, and their bankruptcy had limited impact on the industry. It’s predicted that 80 percent of the remaining real estate companies will go bankrupt, and only the bigger and stronger companies will survive.
No doubt, Evergrande is expected to survive the merciless reshuffle given its size. Forbes ranked its founder Xu Jiayin (Hui Ka Yan) as the richest man in China and the 34th richest person in the world in 2017.
In early 2020, Chinese media announced that 2019 was “the hardest in the past decade and the best in the next decade.” The media predicted an oligopoly era in which only about 50 real estate developers will be needed across the country. Industry experts gave an even more conservative forecast saying “the future of the real estate market obviously will belong to the top 30 companies.”
But Evergrande is unquestionably among the top three real estate giants. China Index Academy statistics show that in 2019, China’s top three real estate companies were Country Garden, Vanke, and Evergrande, with full-caliber revenues of 771.5 billion yuan ($114.4 billion), 631.2 billion yuan ($93.6 billion) and 626.2 billion yuan ($92.8 billion), respectively.
Then why is Evergrande struggling all of a sudden?
The first reason, of course, is the company’s feeble financials. China Business Network published a report on Sept. 24 that clearly described Evergrande’s financial predicament. Evergrande subsidiary Hengda Real Estate had a total asset of 926.8 billion yuan ($137.4 billion), and a total debt of 865.5 billion yuan ($128.3 billion). This translates to an 82 percent debt ratio excluding advance payment. When taking the 116 billion yuan ($17.2 billion) perpetual bond into consideration, the company’s net debt ratio goes up to 445 percent. Evergrande had no choice but to seek strategic investments.
After three rounds of capital increases, Evergrande collected 130 billion yuan ($20 billion) strategic investment from several investors, at the cost of 36.54 percent of Evergrande’s share. But the valuation adjustment mechanism Evergrande signed with the investors planted some potential barriers for Evergrande’s reorganization.
First, Evergrande promised a 165 billion yuan ($24.5 billion) aggregate net profit for fiscal year 2018 to 2020 (which in fact is high dividends regardless of financial gains). Secondly, if Evergrande fails to reorganize and sell Hengda Real Estate to Shenzhen Special Economic Zone Real Estate & Properties and return to the A stock market by 2020, the strategic investors would be entitled to either require Hengda’s top shareholders, Evergrande-controlled Kailong Real Estate or Evergrande Group Chairman Xu Jiayin to buy back shares, or have Kailong give up some Evergrande shares to the investors.
The strategic investors agreed to extend the reorganization deadline to 2021 considering the high dividends Evergrande paid in the past three years. If a reorganization isn’t completed in time, the strategic investor shareholders may still require Evergrande or Xu Jiayin to buy back shares.
I don’t believe Evergrande is the only large real estate company that acquired funds with such harsh terms.
The Abscess Will Burst Sooner or Later
Real estate in China has long been a high-risk industry. The survival of real estate is no longer an economic task, but a political one. Three parties are tied to the real estate market: local governments that rely on land sale for revenue, real estate developers who rely on loans, and millions of home buyers who rely on mortgage loans. All three hang their heads on state-owned commercial banks whose true boss is the Chinese regime.
More than 100 economic crises have occurred since the 20th century and most of them were caused by real estate bubbles. The more recent examples include crises in Japan, the United States, and Spain. China has created the biggest real estate bubble in the world’s modern history, which would have burst a long time ago if it happened in a different country. But the Chinese regime is good at controlling the economy. The Chinese government is in a dilemma though, as it can’t risk letting the bubble burst, nor let it grow bigger. All the regulatory policies China released in recent years aimed at one goal: to let the bubble slowly shrink.
By the way, the majority of homeowners in China do not wish to see house prices decline, because 70 percent of Chinese household assets are real estate, and plunging housing prices will cause significant devaluation. Even those who have paid off their mortgage would hold strong grudges against the government, not to mention those who are still paying. Therefore, the government and the Chinese people hope for relatively stable housing prices.
Lastly, I’d like to respond to the expectation that the Chinese people’s consumption level would grow once the real estate bubble bursts as they’d shift spending from housing purchase to other items. This assumption is highly unrealistic for China. The burst would not promote consumption. On the contrary, due to the household asset devaluation, both willingness and ability to spend will plunge. The following factors cannot be avoided.
1. The mortgage payers will have to continue to pay their mortgages. The per capita debt among Chinese young adults born after 1990 is an appalling 127,000 yuan ($18,826) in 2019, according to Chinese Central Bank statistics. Meanwhile, 560 million Chinese had zero savings in 2019, according to a Central Bank report.
2. The burst of the real estate bubble will cause enormous unemployment across more than 50 real estate-related industries.
Therefore, if the real estate bubble bursts, it would be a nightmare for the government, the banking system, businesses, and the majority of Chinese people. The severity of the situation will depend on how much the bubble can shrink before it bursts. Evergrande’s “threat” to the government is not just a threat, but an imminent future.
He Qinglian is a prominent Chinese author and economist. Currently based in the United States, she authored “China’s Pitfalls,” which concerns corruption in China’s economic reform of the 1990s, and “The Fog of Censorship: Media Control in China,” which addresses the manipulation and restriction of the press. She regularly writes on contemporary Chinese social and economic issues.
Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.