- The communist country is making all efforts to ensure that the Evergrande crisis does not lead to a liquidity crisis.
- Chinese government told Evergrande to not default on dollar bonds, to avoid damaging China’s position as an investment destination.
- The crisis is going to halt China‘s economic growth and end investors’ confidence in the Chinese economy.
The Chinese government is making all efforts to ensure that the possible default by Evergrande does not lead to a liquidity crisis. As per a report by Bloomberg, the People’s Bank of China (central bank of the PRC) has already injected 71 billion dollars into the system to ensure that depositors are paid back, if they want.
With the holiday season arriving in China, the demand for cash would be more, and that coupled with the Evergrande crisis can lead to a liquidity crunch. Many Chinese banks have regularly reassured the depositors and investors that they have enough collateral to recover the loans given to the conglomerate, with more than 77 billion dollars annual revenue.
Whether the banks have enough collateral or not is a matter of debate, but this has surely calmed down the investors. And now, the government (central and local) and regulators are preparing to slowly bury the company. “Local governments have been tasked with preventing unrest and mitigating the ripple effect on home buyers and the broader economy,” said a report by Wall Street Journal.
Also, the Chinese government has told Evergrande to not default on dollar bonds, because it will severely damage the position of China as an investment destination. Given the control that the Chinese government has on the economy, the country would probably be able to deal with the crisis. However, the problem of China’s real estate market is much bigger than the Evergrande group. Even with the phased downfall of Evergrande – which China is aiming for, the banks would be forced to bear huge haircuts because the property that the company owns is selling at 50 to 70% discounts and this will lead to massive loss to the state-owned banks.
The Evergrande crisis raises serious questions over the sustainability of the borrow-to-built model followed by many Chinese companies, especially in the real estate sector. This model has led to the creation of artificial demand and the building of many cities and real estate projects which are not commercially viable. This is the reason behind the fact that China has the highest number of ghost cities – grand cities with very few residents – in the world.
The Chinese government realized the lack of sustainability of this model and recently placed a cap on the amount of debt a company can raise. Companies like Evergrande, which raised huge debt from shadow banks and other financial institutions, are not being able to pay back, and this will lead to the collapse of its shadow banking industry worth trillions of dollars.
A few months ago, The Banking and Insurance Regulatory Commission, China’s apex authority for regulation of banking and insurance sector, had warned the government to prepare for a ‘big rise’ in bad loans as the financial system copes with Coronavirus and increasing sanctions against Chinese companies imposed by countries around the world.
A statement summarising a working conference held by China’s banking regulator in July last year, said, China has to “prevent the cold ash of shadow banking from burning again” while avoiding “a resurgence of chaos in real estate financing.” The statement further added that it also has to “make full preparations to counter changes in the external environment over the long run”.
The regulators are well aware that the artificial demand created by real estate companies is set to collapse. And taking steps to prevent that seems fine, but ultimately these steps are going to halt the economic growth of China and end investors’ confidence in the Chinese economy.