China’s liquidation order for Evergrande Group from a Hong Kong court is not a “Lehman moment” but rather a move that catalyzes Beijing to address its property crisis. The People’s Bank of China has lowered the reserve requirement ratio (RRR) by 50 basis points, effective February 5, to address the underlying cracks in Asia’s biggest economy. This unprecedented step should free up around $140 billion in liquidity, which will be put toward supporting new loan growth.
The PBOC’s delay in announcing the cut denotes urgency on behalf of policymakers, following an extraordinary rout in Chinese equities in January. However, it is more important for Xi’s team to pivot from prioritizing security to economic upgrades. Over the last two years, Xi’s team has pledged to devise a strategy to take toxic assets off property developers’ balance sheets and reduce their ranks. Beijing may adopt a Resolution Trust Company model to revive a sector that generates up to 25% of China’s GDP, potentially avoiding a Japan-like lost decade.
China’s new premier, Li Qiang, has been tasked with resolving the Evergrande crisis, which has caused trillions of dollars of capital to flee Chinese stocks in 2023. The lack of progress in addressing the crisis has led to a winding-up order against the company, which is expected to settle on a liquidator to manage Evergrande and determine how to divide the developer’s interests, most of which are in the mainland. The court’s decision to make a winding-up order is expected to have a significant impact on bondholders, as many investors doubt that the Hong Kong ruling would have received Beijing’s tacit approval.
However, it remains unclear how China will proceed, as many Evergrande projects are operated locally by mainland units. It is also unclear how far Hong Kong’s jurisdiction extends into Xi’s economy, and it is not clear if construction projects involving the completion of homes and flats are about to stop on a dime. The court’s actions could potentially change the narrative of China repeating the mistakes made in the 1990s amid its bad loan crisis.
The Evergrande liquidation event has raised concerns about China’s property sector, as it could potentially spook investors worried about the sector. However, the silver lining from the event is that Xi Jinping’s economic team is working to end China’s debt crises. The property meltdown has put pressure on other developers like Country Garden Holdings, which had exposure to global institutions such as Allianz, Apollo Asset Management, Banque Lombard Odier, BlackRock, Deutsche Bank, Fidelity, HSBC, JPMorgan Chase, and NinetyOne UK.
Xi wants to avoid being blamed for Lehmanizing a global economy already on edge in 2024, with US elections looming. He has not abandoned the aim to reduce the economy’s reliance on property over the long term, meaning some aggressive stimulus options are still off the table. Beijing has been mulling rollbacks of other housing purchase restrictions in first-tier cities in 2023 to stabilize property sales without incentivizing bad behavior.
One risk is avoiding Japan’s lost-decade troubles, as China often fails to get the most from its immense investments. State-owned enterprises (SOEs) have become more dominant than private companies, and China keeps pouring money into infrastructure to prop up economic demand in the face of weak consumer income. This has led to an increasing share of new housing being financed with debt and bought by citizens hoping to gain from price hikes, similar to Japan’s 1980s property bubble.
To maintain the same rate of GDP growth, China must devote ever-larger shares of annual GDP to investment, which is unsustainable and a major factor in China’s current troubles. Premier Li has been focusing on diversifying growth engines and building broader social safety nets to encourage household consumption over savings. However, China’s financial system faces a gap in local government finances, with a $9 trillion mountain of local government financing vehicle (LGFV) debt collapsing. Local Government Financing Bonds (LGFVs) are expected to gradually migrate onto the sovereign balance sheet as local governments issue refinancing bonds to manage LGFV risks.
Policy easing will continue to be needed to secure economic recovery in 2024, but the onus will be on fiscal. Monetary policy support will likely take a background role in 2024 to policy reforms due to pressures on the foreign exchange front and concerns around the sustainability of LGFV debt. Recent events have further increased refinancing pressure on LGFVs over the long term, and transaction costs could add up if LGFVs issue more frequently with shorter-term bonds to refinance long-term debt.
Critical opacity at the highest levels of government is a major reason foreign investors debate whether China is now “uninvestable.” Economist Nicholas Spiro at Lauressa Advisory suggests that it’s high time for China to tackle its “deep-seated structural problems” transparently and credibly.
China is accelerating rescue efforts in line with structural reforms, including a complete suspension of the lending of restricted stocks and a limit on the efficiency of securities lending. The China Securities Regulatory Commission (CSRC) announced these measures to create a fairer market order. Additionally, Beijing is working to merge three of China’s largest bad debt managers into the sovereign wealth fund China Investment Corp, marking a milestone for financial institutions reform.
This move is similar to China’s 1999 attempt to stabilize bad debt managers after the Asian financial crisis. The idea that China is serious about fixing its property sector and reining in local government borrowing is gaining headlines, and Xi and Li should lean into a news cycle that could help change the longer-term narrative towards China doing what it takes to get back on its feet. The move could help change the longer-term narrative towards China doing what it takes to get back on its feet.
