1 How the Hamas attack could impact the PRC
On Oct. 7, 2023, the Palestinian militant group Hamas launched a deadly attack against Israel from the Gaza Strip, killing at least 900 Israelis according to news reports. Israel formally declared war on Hamas on Oct. 8. On Oct. 9, the leaders of France, Germany, Italy, the United Kingdom, and the United States issued a joint statement in support of Israel and condemning Hamas.
PRC response
On Oct. 8, a PRC foreign ministry spokesperson urged “relevant parties to remain calm, exercise restraint and immediately end the hostilities to protect civilians and avoid further deterioration of the situation.”
The spokesperson continued, “The recurrence of the conflict shows once again that the protracted standstill of the peace process cannot go on. The fundamental way out of the conflict lies in implementing the two-state solution and establishing an independent State of Palestine. The international community needs to act with greater urgency, step up input into the Palestine question, facilitate the early resumption of peace talks between Palestine and Israel, and find a way to bring about enduring peace. China will continue to work relentlessly with the international community towards that end.”
In response to the PRC’s statement, Yuval Wak, a senior official at the Israeli embassy in Beijing, said, “When people are being murdered, slaughtered in the streets, this is not the time to call for a two-state solution.”
On Oct. 9, PRC foreign ministry spokeswoman Mao Ning said in response to a question on Hamas attack, “We oppose and condemn acts harming civilians. The priority now is to end hostilities and restore peace as soon as possible and work together to deescalate the situation.”
US pressure
On Oct. 9, U.S. Senate Majority Leader Chuck Schumer told Xi Jinping in a meeting in Beijing, “The ongoing events in Israel over the last few days are nothing short of horrific. I urge you and the Chinese people to stand with the Israeli people and condemn the cowardly and vicious attacks.”
Schumer, who was leading a bipartisan congressional delegation on a trip to Asia, added, “I say this with respect, but I was disappointed by the foreign minister’s [Wang Yi] statement that showed no sympathy or support for the Israeli people during these troubled times.”
Schumer told reporters after his meeting with Xi, “A bunch of us made the request that China use its influence in Iran to not allow the conflagration to spread.” Schumer added that Xi told him that the PRC has “ influence with Iran in many different ways” and “we asked them to do everything they could.” Schumer said that the Chinese side “said they would deliver the message to the Iranians.” Iran denies any role in the Hamas attack; an Oct. 8 article by The Wall Street Journal claims that Iran helped plot the attack on Israel, citing senior members of Hamas and Hezbollah
According to PRC state mouthpiece Xinhua, Xi Jinping told Schumer and his delegation that “Sino-U.S. relations are the most important bilateral relations in the world,” and the “common interests of the two countries far outweigh their differences.” Xi also said that “competition and confrontation are not in line with the trend of the times,” and “the ‘Thucydides Trap’ is not inevitable.”
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The Wall Street Journal reported on Oct. 9 that Washington and Beijing are “taking actions aimed at setting the tone in the relationship and coming into the summit [between Xi Jinping and President Joe Biden in the U.S. in November] in a position of strength,” citing people familiar with recent discussions on both sides.
A senior administration official told the Journal, “We have decades of experience talking to and even working with our competitors when our interests call for it. We are not going to take a step back from our interests, including our security.”
The PRC embassy in Washington said, “China firmly opposes the U.S.’s overstretching of the national security concept and abuse of export control measures to wantonly hobble Chinese enterprises.”
Our take
Hamas’s attack on Israel, similar to Russia’s invasion of Ukraine, has made the international community even more wary of the possibility of a PRC invasion of Taiwan. This means that the Xi leadership will likely face even greater geopolitical headwinds and find international sentiment souring even quicker towards the PRC. Businesses and investors who are concerned about growing geopolitical risks and its impact on China could step up efforts to move supply chains, operations, and headquarters out from the mainland, or developments that would worsen the PRC’s economic problems and deepen the many crises facing the CCP regime.
We currently believe that there is a very low probability of the PRC seizing the opportunity of war in Eastern Europe and the Middle East, as well as America’s increasingly divided attention at home and abroad, to invade Taiwan. It is highly risky for Xi Jinping and the CCP regime to engage in kinetic military operations at a time when the Chinese economy is floundering and Xi is focusing on factional struggle after likely having been manipulated into removing his political allies from key positions. That being said, Beijing will find it a steep challenge to convince observers that it is not preparing for an invasion, given the CCP’s previously stated ambitions concerning Taiwan and the PRC’s various military and paramilitary operations in the Taiwan Strait, the East China Sea, and the South China Sea.
Beijing’s non-alignment with the U.S. and its allies in condemning Hamas and supporting Israel will further convince the West that the Xi leadership is looking to subvert rather than conform to the rules-based international order. This could lead the Biden administration and other Western governments to maintain or increase pressure on the Xi leadership and the CCP even as they continue to have diplomatic engagements with the PRC, including supporting Taiwan (militarily, economically, etc.) and promoting the notion of Taiwan as an “independent country,” tightening export restrictions on advanced technology, and condemning the PRC over its human rights abuses. Heightened Western pressure on Xi and the CCP is likely to further shake foreign confidence in China, resulting in greater outflows and a more rapid deterioration of the Chinese economy.
Growing geopolitical pressures against the PRC could convince Xi Jinping to move quickly to stabilize the political situation at home so that he can take more decisive action later to deal with external threats to the regime. To that end, Xi could speed and step up anti-corruption efforts to purge his remaining factional enemies and their cronies, as well as double down on propaganda and other efforts to solidify his paramount position in the Party (定於一尊).
2 Country Garden default warning, Evergrande liquidation risk point to widening property sector crisis
Country Garden warns of default
Oct. 10
Country Garden said in a filing with the Hong Kong stock exchange that its sales and financing were facing “significant challenges,” and that its available funds have kept decreasing. Therefore, the developer “expects that it will not be able to meet all of its offshore payment obligations when due or within the relevant grace periods, including but not limited to those under the U.S. dollar notes issued by the company.” The filing added that “such non-payment may lead to relevant creditors of the Group demanding acceleration of payment of the relevant indebtedness owed to them or pursuing enforcement action.”
Country Garden had previously not made a due payment of HK$470 million ($60 million) “under certain of its indebtedness.” The company’s total liabilities are as high as 1.36 trillion yuan ($187 billion), of which $11 billion are outstanding offshore bonds. Country Garden has missed initial deadlines on interest payments on several bonds in recent weeks, with some of the grace periods of those debts set to end in October 2023.
Evergrande investors warn of ‘uncontrolled collapse’
Oct. 9
The Wall Street Journal reported that a group of investors holding some of China Evergrande’s bonds had issued a statement questioning the company’s effort to win the support of regulators to pursue its bond restructuring, which had been canceled in late September after almost two years of discussion with investors. The investors also wrote that Evergrande is on course to be wound up at a hearing on Oct. 30, 2023 unless the developer convinces regulators to approve the restructuring deal.
“This will likely lead to the uncontrolled collapse of the group,” wrote the investors, who hold over $6 billion of Evergrande’s bonds in notional terms.
Evergrande previously said in a filing on Sept. 22 that it needed to abandon its restructuring plan due to worse-than-expected property sales and would need to find another path forward that “reflects the company’s objective situation.” On Sept. 28, the company announced that its founder Hui Ka Yan had been detained by the authorities.
New home transactions plummet during ‘Golden Week’
Oct. 8
Data from China Index Academy for the period of China’s “Golden Week” holiday (Oct. 2 to Oct. 8) showed drops in the transaction volume of new commercial housing by as much as 70 percent as compared to the prior week:
- 50 key cities: 13,140 units sold, or down 70.5 percent from a week ago and down 30.6 percent year-on-year.
- First-tier cities: 2,239 units sold, or down 76.05 percent from a week ago and down 16.46 percent year-on-year.
- Second-tier cities: 7,365 units sold, or down 69.75 percent from a week ago and down 36.68 percent year-on-year.
- Third- and fourth-tier cities: 3,065 units sold, or down 73 percent from a week ago and down 33.25 percent year-on-year.
Small- and medium-sized banking crisis
Bank run in Hebei?
On Oct. 7, Cangzhou Bank, a small- and medium-sized bank in Hebei Province, issued a statement to clarify that the bank’s loan data included in a “detailed list of loans that Evergrande owes to banks” that is being circulated online is “seriously inaccurate.” Cangzhou Bank urged people not to believe the “rumors” and spread them, and that the bank reserves the right to take legal action against those who do so.
Cangzhou Bank added in its announcement that China Evergrande and its subsidiaries owe 345 million yuan to the bank as of Oct. 6, 2023. Also, the bank had successfully sued Evergrande in July 2022 and is currently carrying out collateral disposal procedures.
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On Oct. 9, several videos circulating on the internet showed many depositors queuing up to withdraw money at multiple Cangzhou Bank branches in Hebei Province. Many depositors also found that the bank appeared to have temporarily suspended online transfers, which left them unable to withdraw funds.
There were also many rumors being spread about Cangzhou Bank, including one about how the People’s Bank of China allegedly provided overnight funding support to the bank to allow it to resume online transfer services. On Oct. 9, three local financial management authorities issued a joint statement to refute the “rumors” about Cangzhou Bank.
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Mainland media cited an information disclosure report for the first half of 2023 as showing that Cangzhou Bank’s operating income from January to June 2023 was 2.317 billion yuan (up 23.18 percent year-on-year) while its net profits over the same period were 669 million yuan (up 5.92 percent year-on-year). As of June 30, 2023, the bank had 207.969 billion yuan in total deposits, 149.604 billion yuan in total loans, approximately 2.618 billion yuan in non-performing loans, 3.274 billion yuan in overdue loans, and a provision for loan losses of 4.194 billion yuan.
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Official mainland media China Securities Journal reported on Oct. 9 that multiple auction platforms, including Ali Auction and JD Auction, had listed auctions where the opening bid price for stakes in several small- and medium-sized banks at 1 yuan, including Shunde Rural Commercial Bank, Lanzhou Rural Commercial Bank, Jiangmen Rural Commercial Bank, and the Bank of Anshan.
China Securities Journal added that most of the shares were held by natural persons (i.e. an individual human being, and not an organization or business) and the listed auctions were looking to sell 100,000 shares or fewer. The media outlet added that there were very few bidders for the shares despite the 1 yuan starting price.
Our take
1. The developments above indicate that China Evergrande is headed for liquidation and Country Garden, which replaced Evergrande as the leading property developer in China after the latter’s crisis broke out, will likely default on at least some of its debts. These are more signs that China’s real estate sector is set for a “hard landing.”
Country Garden and Evergrande’s plight also affirm a number of our previous predictions and analyses on the topic:
- August 2020: After the CCP authorities introduced the “three red lines” restrictions for the property sector, we analyzed that “the CCP’s de-risking measures will likely exacerbate its financial risks and trigger serious financial problems, including the bursting of the property bubble.” We also wrote, “Should the CCP’s derisking policies burst the property bubble, the scale of non-performing loans will go up sharply. In this scenario, China will not only see economic Gray Rhinos, but political Black Swans.”
- Sept. 16 2021: When the Evergrande crisis was unfolding, we analyzed that “the CCP is unlikely to bail out Evergrande or provide the property developer with unconditional financial assistance even as the company’s debt crisis worsens. We also noted at the time that “the CCP can hardly allow ‘too-big-to-fail’ Evergrande to simply default and declare bankruptcy” due to the risk of triggering systemic financial risks and social unrest; when the CCP authorities did not introduce effective policies to rescue the real estate sector, we later outlined a potential liquidation scenario where state-owned enterprises could step in to take over Evergrande assets, land, and projects to mitigate financial and social problems stemming from the company’s bankruptcy and liquidation. We further noted in the Sept. 16, 2021 newsletter, “As Evergrande’s crisis deteriorates further, Hui Ka Yan is at risk of being arrested as the Xi leadership looks to make a political point.”
- Sept. 23, 2021: We wrote that “financial contagion from Evergrande’s debt crisis remains very real” and the company’s “inability to make repayments threatens the health of China’s property and financial sectors on the whole, driving up the risk of cross defaults.”
2. Financial contagion from China’s real estate sector has been spreading since the Evergrande crisis broke, and the contagion risks now appear to be concentrated in small and mid-sized banks in China.
The case of Cangzhou Bank appears to be an example of how property sector risks are impacting small- and medium-sized banks. Cangzhou Bank claimed that China Evergrande and its subsidiaries owe just 345 million yuan to it and collateral disposal procedures are being carried out by the courts after it successfully sued Evergrande. However, the bank might not get adequate repayment after the liquidation of Evergrande’s collateral given that property prices have been falling amid the real estate sector crisis. Evergrande’s inability to repay Cangzhou Bank will affect the bank’s profitability and operations; the bank’s loan losses (4.194 billion yuan) for the first half of 2023 are already 6.3 times greater than its net profits (669 million yuan).
Given that many small- and mid-sized banks invest a lot of their capital in real estate and are the receivers of local municipal bonds, we have reason to believe that Cangzhou Bank could become technically insolvent in the event of a bank run. The liquidation of Evergrande will likely have an even greater impact on Cangzhou Bank and other small and medium-sized banks that have lent to the developer.
Another sign of trouble at small and medium-sized banks is the growing number of financial institutions that are behind in commercial paper repayments. According to the Shanghai Commercial Paper Exchange’s list of overdue entities, there were 33 financial institutions overdue in June 2023, 271 in July 2023, 218 in August 2023, and 247 (including three Cangzhou Bank branches) in September 2023.
Two intractable problems are preventing the CCP authorities from resolving the property sector crisis. The first is the rapid deterioration of the Chinese economy and the PRC entering a “balance-sheet recession,” which makes people hesitant to buy property due to declining incomes and preference to pay off loans instead of taking on debt over concerns about asset prices and economic growth prospects. The second is China’s shrinking demographic, including the possibility that the actual toll of COVID-related deaths could be significantly higher than the official figure, and the impact of a much smaller population on domestic demand.
Beijing’s struggles to rescue the real estate sector with its various measures introduced over the past couple of months is an indirect indicator that the Xi leadership has no good options for turning the Chinese economy around. Further economic deterioration and triggering of financial risks will eventually transform into political risks for Xi Jinping, and how Xi deals with heightened political risks could endanger the entire CCP regime.
