Evergrande, other real estate companies may not be saved by the Communist Party


In recent weeks, the world’s most indebted developer, the Chinese group Evergrande, a real estate holding company, has taken the world by storm. With assets across sectors spanning real estate services, electric vehicles and bottled water, Evergrande missed several interest payments before making a key payment to bondholders on October 22. With an estimated liability of $ 300 billion, Evergrande’s payment problems are affecting global institutional investors, offshore bondholders and home buyers in China.

Conventional wisdom has suggested that the Chinese Communist Party intervened at the corporate level to stem the negative effects on the economy. After all, earlier this year the Chinese government ordered Chinese banks to grant loans to state-owned China Huarong Asset Management to stem the risk of market contagion and stabilize its cash flow. Huarong’s US dollar offshore bonds fell in value when it failed to release its financial results for 2020 and the company suspended trading in its shares in April.

Why, then, did the Chinese central government not step in to save Evergrande?

In recent weeks, the world’s most indebted developer, the Chinese group Evergrande, a real estate holding company, has taken the world by storm. With assets across sectors spanning real estate services, electric vehicles and bottled water, Evergrande missed several interest payments before making a key payment to bondholders on October 22. With an estimated liability of $ 300 billion, Evergrande’s payment problems are affecting global institutional investors, offshore bondholders and home buyers in China.

Conventional wisdom has suggested that the Chinese Communist Party intervened at the corporate level to stem the negative effects on the economy. After all, earlier this year the Chinese government ordered Chinese banks to grant loans to state-owned China Huarong Asset Management to stem the risk of market contagion and stabilize its cash flow. Huarong’s U.S. dollar offshore bonds fell in value when it failed to release its financial results for 2020, and the company suspended trading in its shares in April.

Why, then, did the Chinese central government not step in to save Evergrande?

The answer lies in the sector. For strategic sectors, such as banking and telecommunications, seen as essential for the national technological base, national security imperatives and the competitiveness of national industry, the Communist Party of China tends to centralize and strengthen control over the state in market coordination and property rights agreements. For less strategic sectors, the Chinese central government has shown its willingness to deregulate and decentralize market governance to local governments, business and industry associations and other market players. I call this “bifurcated capitalism”.

Because it is perceived to be of less strategic value to the national technology base and national security than more critical sectors, Evergrande and its future depend on local government and business stakeholders rather than the central state. Chinese in search of national political consolidation and legitimacy to maintain their authoritarian regime. .

Yet even without an impending liquidity crisis, in many ways real estate is your typical strategic sector. It is the basis of political stability and a third of the revenues of local communities. In addition, all agricultural and urban land in China is legally owned by the state, either directly or through rural communities.

Precisely because real estate property already belongs to the state, at the start of the reform era, the state introduced competition and allowed local authorities and private interests to develop generations of use, exchange and of profit. As a result, decades later, Evergrande and others like him are firmly entrenched in the decentralized and deregulated parts of the Chinese economy.

A number of these local state and market players govern competition in real estate, which accounts for 29% of the economy. The agreements between local authorities and companies negotiated by Evergrande and its subsidiaries totaled 778 projects underway in 223 Chinese cities.

The perceived strategic value of sectors influences the governance of markets, but the central government responds to internal and external pressures, which change according to circumstances. Moreover, the existing institutions regulating an industry shape the way the central government reacts and makes decisions.

In other less strategic and decentralized sectors, such as textiles, responses to increased economic and political pressures have in the past led to central state intervention at the enterprise level. To stem the excessive expansion during the financial crisis in East Asia, Beijing resurrected centrally dismantled bureaucracies and entered textile factories to cut brooches.

More recently, in October 2020, the Chinese government ordered cotton mills to stop purchasing supplies from Australia. It came at the height of diplomatic tensions between China and Australia over allegations of Chinese interference in Australia’s internal affairs and the Australian Prime Minister’s call for an investigation into the origins. of the COVID-19 pandemic.

With the majority of the most indebted real estate developers based in China, the Chinese central government has limited subprime lending, with rules such as the “three red lines” – a 70% cap on liabilities, a 100% cap on net debt to equity, and a cash to short-term debt ratio of at least one. The state has also eased credit to homebuyers to support healthy developers.

But provincial governments and localities are the ones that have banned or removed Evergrande as a viable developer in local projects. This included Huaibei Mining Group, which requested court termination of construction projects with Lu’an Hengda Real Estate, a subsidiary of Evergrande. Evergrande is also involved in disputes with contractors and suppliers.

Other regional authorities have negotiated deals, such as the sale of Evergrande’s stake in Shengjing Bank based in Shenyang, Liaoning Province. Global investors supported the sale of this stake as “preferential treatment” for some lenders over others.

However, this interpretation misses the nuances of Chinese capitalism in less strategic sectors where business and politics are local. To settle local debts, Evergrande transfers its stake in a bank owned by the municipal government of Shenyang to the bank’s subsidiary.

The story of Evergrande illustrates the institutional foundations of Chinese capitalism that continue to shape the trajectory of globalization and China’s development outcomes. Beijing introduced competition in less strategic sectors from the 1980s and decentralized market coordination to local governments and trade offices throughout the 1990s.

Empowered to make economic decisions, local governments and trade offices approve entry into the market, which in many cases is completely liberalized. These decentralized communities, including sectoral and professional associations, act as economic players in a very competitive landscape.

Private enterprises, many of which have been restructured from urban and village enterprises owned and operated collectively by local authorities or ceded to state-owned, or foreign-invested, corporations face the vagaries of local politics, the regulatory arbitrariness and lack of central will and regulatory capacity in the application of macroeconomic rules.

Fiscal policies, which centralize control of tax revenues that Beijing then distributes among provinces, prompt local authorities to rely on the sale of land use rights and borrow land used as collateral to finance projects and services. local. Hyper-competition and battles for land reign. Forced demolitions and evictions by local governments have only worsened under Chinese President Xi Jinping’s “rural revitalization” policy.

Decentralization without the regulatory institutions necessary to tax and manage competition, in addition to uneven enforcement of local regulations, has created and exacerbated the economic, social and political problems that now challenge China’s authoritarian rule. These problems include insufficient regulatory capacity to enforce rules regarding human and animal health and safety as well as the environment. They also include growing corruption at all levels of government and across the economy.

Private entrepreneurs are the engine of China’s economic growth. They also participated in the country’s oversized and saturated real estate markets, building “ghost towns”. They are keen to stay in business and not upset the political order of the country. Indeed, the most successful businessmen, including the founder of Evergrande, Xu Jiayin, are invited to represent the system of the Local and National People’s Congress.

Value-added telecommunications services that operate on top of the state-owned communications infrastructure are a sector comparable to real estate development with the various ownership arrangements of its various market players. Perhaps the best-known example is the online banking and wealth management platform Ant Group, founded by Jack Ma. For years, Ma and his businesses have operated without much intervention and oversight from the company. ‘State. On the contrary, the state courted foreign direct investment and then re-regulated for the benefit of the growth and development of the national sector.

Yet the stakes changed when Ma pushed the boundaries by questioning state management of regulatory matters. Ant Group’s monopoly position came to be seen as disrupting state control over banking, telecommunications and, most importantly, the Communist Party government.

For now, global investors should remain vigilant and not expect the kind of state intervention the world is used to from Xi and Beijing. The best due diligence for business decisions is to understand the political logic of the institutional foundations of Chinese capitalism.

Previous There are still options to change a shaft for less than half a mil
Next Four ways McGill researchers are spearheading pandemic innovation