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Evergrande’s debt crisis: Time to ditch China

by Gordon G. Chang, opinion contributor - 09/22/21 12:16 PM ET

Stocks tumbled around the world on Monday as markets focused on the severe troubles of property developer China Evergrande Group. A Chinese debt crisis will — either now or in the near future — bring down China’s economy, and the U.S. must delink from that country to reduce the damage to itself.

A crucial test comes Thursday, when Evergrande must pay $83.5 million in interest on its March 2022 bond. Payment of 232 million yuan due the same day has been “settled through negotiations.” Then, on Sept. 29, $47.5 million comes due on its March 2024 bond.

The betting on Wall Street is that Evergrande, the world’s most heavily indebted property company with a stunning $305 billion in obligations, will not become China’s Lehman Brothers.

Barclays on Monday noted that “a true ‘Lehman moment’ ” would require “a lenders’ strike across large parts of the financial system, a sharp increase in credit distress away from the real estate sector, and banks being unwilling to face each other in the interbank funding market.” For this to happen, most believe, “Chinese authorities would need to make a series of policy mistakes in response to the crisis.”

Behind China’s strong currency walls — the renminbi is not convertible on the capital account — Beijing managed to avoid the worst effects of the 2008 downturn. Chinese authorities averted disaster by overseeing a massive expansion of credit and forcing lenders to rollover debt of distressed companies.

Some believe Beijing will lean on lenders to not call defaults should Evergrande not pay interest within its 30-day grace periods. There is confidence that central authorities can, once again, support the company and thereby avoid disaster.

Beijing, if it wanted to, could save Evergrande, but confidence that China’s technocrats and political leadership can avoid a contagion is misplaced. In short, they don’t have sufficient resources. For starters, their economy, weighed down by debt and COVID-19, is not producing enough cash. Before the disease struck in late 2019, China had been incurring almost seven times more debt than it was producing gross domestic product. The ratio has undoubtedly deteriorated since then.

Moreover, Chinese leader Xi Jinping has been busy attacking the most productive Chinese companies, causing, at last count, a $3 trillion fall in their market value. His Maoist-inspired “common prosperity” campaign has, understandably, scared away both domestic and foreign investment.

China has reported it held $3.23 trillion in foreign exchange reserves as of August, but even if that number is accurate — which is unlikely — then foreign currency is useful only for retiring obligations denominated in foreign currency. China has a local currency crisis, however. Printing renminbi in the absence of real growth would lead to hyper-inflation, Weimar Republic-style.

There are too many Evergrandes, like Sinic Holdings Group, a Shanghai-based property developer. Its stock dropped 87 percent on Monday before trading was halted on the Hong Kong Stock Exchange. Guangzhou R&F Properties also seems to be facing serious difficulties. Chinese banks are, of course, exposed.

In the meantime, China’s property sector, constituting more than a quarter of the economy, is seizing up as parties no longer trust one another. Contractors are not working without credible assurances of payment, suppliers are not accepting commercial paper for materials, and homebuyers are reluctant to close on purchases or make deposits on unfinished apartments. Home sales are coming down quickly. In this environment, even financially solid developers can fail.

Chinese leaders can perhaps prevent a Lehman-style crash by mobilizing state enterprises and banks to take up the obligations of Evergrande and other troubled businesses, but then the country would face a decade or more of stagnation, much like Japan’s “Lost Decade” after the 1989 Tokyo stock crash.

“China’s official debt-to-GDP ratio has soared by nearly 45 percentage points in the past five years, leaving it with among the highest debt ratios for any developing country in history,” reports Michael Pettis of Peking University. Evergrande’s debt by itself, he states, amounts to about 3 percent of the country’s annual GDP. Kyle Bass, the Dallas hedge-fund manager, believes China’s leverage is at least three times that of the U.S. prior to the 2008 crisis.

China’s fundamental problem is that there is too much debt in too many places. “This wouldn’t be as much of a problem if Chinese property developers, state-owned enterprises, local governments, and even ordinary households did not all have excessively high debt levels,” Pettis writes on the Carnegie Endowment site.

So China will have to face the music sometime, whether or not it has a “Lehman Moment,” and the U.S. can protect itself only by delinking its economy and markets from China’s as fast as it can. It is unwise to be joined to a country that, one way or another, will go down the tubes.