1 Evergrande’s liquidation foreshadows concentrated outbreak of crises
On Jan. 29, the Hong Kong High Court ordered the liquidation of China Evergrande after noting that the developer had been unable to come up with a concrete restructuring plan more than two years after defaulting on its offshore debts and following several court hearings.
Justice Linda Chan appointed Alvarez & Marsal as the liquidator. In theory, the court ruling could allow liquidators to attempt to take control of some Evergrande assets worldwide, including in mainland China, to sell the company’s assets to make debt repayments. However, it is unclear whether mainland courts would accept the Hong Kong liquidation order.
After the Hong Kong court announced the winding up of Evergrande, shares of China Evergrande fell by 21 percent before trading was suspended, bringing a 12-month decline to 90 percent. Stocks of China Evergrande New Energy Vehicle and Evergrande Property Services also fell by 13 percent and 9 percent respectively before paring; both subsidiaries later applied for trading resumption after being suspended.
Background
1. The Evergrande liquidation petition was filed in June 2022 by Top Shine, an investor in the Evergrande unit “Fangchebao.” The petition said that Evergrande failed to honor an agreement to repurchase shares it had bought in the unit.
2. Evergrande had been working on a $23 billion debt restructuring plan with an ad hoc bondholder group for the past nearly two years. The plan was put on hold after Evergrande founder Hui Ka Yan (Xu Jiayin) was placed under investigation for suspected crimes at the end of September 2023.
3. In the first half of 2023, Evergrande reported revenues of 128.18 billion yuan, with a gross profit of 9.8 billion yuan. However, the company incurred operating losses of 173.8 billion yuan during the same period.
Non-operating losses, including litigation, land repossession, equity disposal, and asset impairment, amounted to 15.03 billion yuan.
Income tax expenses reached 6.84 billion yuan, resulting in a total net loss of 39.25 billion yuan.
Evergrande’s overall liabilities stand at 2.3882 trillion yuan (1.7842 trillion yuan excluding prepayments for property sales) and total assets are at 1.7439 trillion yuan.
4. Several Chinese property developers are facing financial collapse since the onset of the real estate debt crisis in 2021. At least three Chinese developers had previously been directed by Hong Kong courts to undergo liquidation before the recent Evergrande ruling.
A judicial cooperation mechanism established in 2021 allows courts in Hong Kong and the mainland to mutually recognize and assist each other in matters of corporate liquidation in three cities—Shenzhen, Shanghai, and Xiamen. The mechanism, however, stipulates that mainland courts reserve the right not to cooperate with Hong Kong courts if they determine that Hong Kong procedures “violate the basic principles of mainland laws or go against public order and good customs.”
Our take
1. The Hong Kong High Court’s order that China Evergrande, which was once considered to be “too big to fail,” undergo liquidation marks the end of an era for China’s real estate industry. Should the mainland courts uphold the liquidation order, then several of our analyses and predictions on the Evergrande development in recent years would be validated:
September 2021
We wrote:
- The CCP authorities are unlikely to bail out Evergrande. On the other hand, the authorities cannot allow Evergrande to simply default and declare bankruptcy.
- We warned foreign investors about the risks of Evergrande’s debt crisis.
October 2021
We wrote:
- Evergrande’s debt crisis could expand and escalate risks of financial contagion.
October 2023
We wrote:
- The arrest of Hui Ya Kan suggests that the Xi leadership is paving the way to hold Evergrande and its executives responsible for creating the debt mess through its business practices and corruption because a hard landing for the property sector looks unavoidable.
- Hui’s arrest indicates that Beijing is likely willing to allow Evergrande to declare bankruptcy and enter into liquidation.
2. The winding up of Evergrande is a sign that the CCP authorities are essentially helpless to prevent a hard landing for China’s real estate sector.
Evergrande’s default and liquidation is not an isolated incident. Since the surfacing of the real estate debt crisis in 2021, more than 50 Chinese developers have defaulted, with Evergrande being the most prominent among them.
Country Garden, which replaced Evergrande as China’s leading real estate enterprise, also saw its debt problems worsen in 2023. Country Garden has an estimated 1.43 trillion yuan in liabilities (second only to Evergrande), but its realized sales in 2023 amounted to just 174.28 billion yuan, or a year-on-year decline of 50 percent. On top of this, Country Garden has to deliver over 480,000 units of pre-sold homes in 2024.
Country Garden has been steadily selling assets to meet its debt obligations and maintain liquidity. On Jan. 22, the developer put up five of its commercial properties in Guangzhou (total value of 3.818 billion yuan) for sale; whether or not Country Garden can find buyers for those properties in the current market is uncertain. Country Garden is also selling off its overseas assets and projects, including developments in Australia, Malaysia, and the United Kingdom.
With the CCP authorities “allowing” the liquidation of Evergrande, it cannot be ruled out that Country Garden’s creditors could find reasons to sue the latter in Hong Kong. This increases the risks of Country Garden facing liquidation.
The worsening real estate crisis appears to be part of the reason why the Xi leadership appears to be downplaying its “houses are for living in, not speculation” policy and granting local governments so-called “full autonomy” over real estate regulations. Beijing is likely hoping that the easing of property restrictions in the localities can improve the overall real estate debt crisis and even bring some relief to the increasingly cash-strapped local authorities.
3. The liquidation of Evergrande would likely see a spreading of financial contagion as the resolution of its debt problems drags out for several years.
Evergrande’s investors, financial institutions, and construction and supply companies will be hoping to receive payouts from the liquidation process, but not all will get what they are owed. Companies that are reliant on Evergrande staying in operation for their business would be hit the hardest, and some could be forced to fold.
Meanwhile, financial institutions could see an uptick in non-performing loans corresponding with the rise in unfinished pre-sold projects, homeowner defaults, and the protracted Evergrande liquidation process. The increase in non-performing loans could exacerbate medium to long-term financial risks in the financial system.
The financial problems stemming from Evergrande’s liquidation could be one of the reasons driving the CCP authorities’ recent lifting of restrictions on the foreign ownership ratio in the financial sector (see item two in this newsletter).
4. Evergrande’s liquidation could be the first domino to fall and cause a concentrated triggering of crises in China in 2024.
Real estate and its related industries were once a central force driving economic growth in China. A hard landing would affect not just the real estate sector and related industries, but also impact local government revenue. For instance, local land transfer revenue reached 8.68 trillion yuan in 2021, but declined to 6.68 trillion yuan in 2022 (down 23.3 percent year-on-year). Local land transfer revenue dropped further to 4.2 trillion yuan from January to November 2023, a 17.9 percent decline from the previous year and a 50 percent drop from 2021.
The CCP authorities have yet to identify new sources of revenue to offset the shortfall caused by the real estate downturn. In what appears to be a stopgap, the authorities increased the fiscal deficit ratio and boosted central government fund transfers to the localities. In 2022, central government revenue was approximately 9.5 trillion yuan while transfers to local governments were as high as 9.7 trillion yuan. Local government transfers in 2023 are likely to be even higher; the increased strain on the central government’s coffers would not be welcome at a time when economic growth is likely negative.
Reduced local government revenue would worsen the local government debt crisis and governing capability. This in turn weakens Beijing’s control over society and leaves the CCP regime more vulnerable to political problems.
All in all, the winding up of Evergrande could trigger several of China’s internal and external risks in a concentrated fashion. In our China 2024 Outlook, we wrote that the CCP authorities are likely unable to resolve most of the risks and would move to “cover up regime crises by attempting to further strengthen control over society and stepping up propaganda.” Also, the worsening of China’s internal and external crises could “lead to escalations in the CCP factional struggle and trigger political Black Swans.”
2 Beijing looks to offload risks in easing restrictions on foreign investment in financial institutions
Jan. 25
Xiao Yuanqi, deputy director of the PRC National Financial Regulatory Administration, told a press conference that the regulatory body had recently launched more than 50 financial opening up measures. Among these measures include the scrapping of restrictions on the ratio of foreign shareholding in banking and insurance institutions, and the substantial easing of entry thresholds for foreign institutions. Xiao said that foreign investors can now hold 100 percent of shares of a banking or insurance institution in China.
Xiao said that the foreign-funded financial institutions that have been approved include insurance companies, financial management companies, foreign currency brokerage companies, as well as insurance asset management companies. He added that the potential business scope of a foreign banking or insurance institution is now identical to that of their Chinese counterparts. Further, all restrictions pertaining to the financial industry on the negative list for foreign investment access have been completely removed.
Xiao said that foreign-funded banks had opened 888 business branches in China, with total assets reaching 3.86 trillion yuan by the end of 2023. Overseas insurance institutions had also established 67 business branches and 70 representative offices by the end of 2023, with total assets hitting 2.4 trillion yuan. Xiao said that the market share of overseas insurance institutions was 10 percent, or “quite a high level.”
Jan. 28
Bloomberg News reported that state mouthpiece Xinhua had deleted a short report stating that China Cinda Asset Management Co., China Orient Asset Management Co., and China Great Wall Asset Management Co. would be “merged” into China Investment Corp., the regime’s $1.24 trillion sovereign wealth fund. The Xinhua report noted that the move was part of the PRC’s plan to reform institutions.
Bloomberg previously reported in May 2023 that the PRC was considering transferring the regime’s stakes in the three bad debt managers into Central Huijin Investment Ltd., which is a unit of China Investment Corp. Bloomberg also noted that the Ministry of Finance holds a controlling stake in each of the three bad debt managers, or 58 percent in Cinda, 71.6 percent in Orient, and 73.5 percent in Great Wall.
Bloomberg also reported that the PRC had created Huarong, Cinda, Orient, and Great Wall to purchase bad loans from banks in the aftermath of the Asian financial crisis in the late 1990s. Bloomberg added that the firms “later expanded beyond their original mandate, creating a labyrinth of subsidiaries to engage in other financial businesses, including shadow lending.”
Jan. 31
Bloomberg reported that the PRC is planning to merge “hundreds of rural lenders into regional behemoths amid growing signs of financial stress.”
Bloomberg added that PRC policymakers have “pinpointed tackling risks at the $6.7 trillion sector as one of its top priorities for the year” and that means “another wave of consolidation is on the way across the nation.”
Bloomberg said that the latest move to merge lending cooperates started in 2022 when regulators urged the transformation of 25 provincial-level cooperates established in the early 2000s into modern financial enterprises to further eliminate risks. According to data compiled by Bloomberg, the authorities have since approved seven provinces to consolidate their more than 500 smaller lenders either through mergers or a shareholding structure.
Backdrop
On Jan. 22, China’s stock markets plummeted across the board, with several individual stocks and indexes hitting record or interim lows and the Shanghai index falling below 2,800 points. The Shanghai index later rallied above 2,900 points after the “national team” stepped in and the CCP authorities issued “positive” news in support of the markets.
However, the markets began to fall again in the week of Jan. 29. On Jan. 31, the Shanghai index closed at 2,788.55 points. At the end of January, the Shanghai Composite Index had fallen by more than 6 percent for the year, the Shenzhen Component Index was down more than 13 percent, the Growth Enterprise Market was down more than 16 percent, and the SSE Science and Technology Innovation Board 50 Index was down by nearly 20 percent.
Our take
1. The CCP authorities’ allowing foreign investors to hold up to 100 percent of shares of a banking or insurance institution in China appears to be driven by practical necessity rather than a genuine attempt at greater “opening up.”
Notably, Beijing has not announced that it is moving away from “Chinese-style modernization,” “Sinicized Marxism,” and other political theories derived from Marxism-Leninism. Nor has the Xi leadership issued any statements about how finance will no longer serve “socialist construction” and other agenda items meant to strengthen the communist regime that were announced at the 2023 Central Financial Work Conference. That is to say, the CCP has not abandoned socialism in favor of capitalism and greater liberalism.
As long as the CCP clings to its pernicious ideology, it will continue to work towards its ultimate goal of ushering in the communist “utopia” for both China and the world, or in the parlance of liberal democracies, entrench authoritarian dictatorship in China and reshape the current U.S.-led international order. And given its “survival-dominance” dynamic, CCP has no qualms with “backtracking” and taking roundabout paths while on the “long march” to achieving its ultimate objectives.
The Xi leadership is also not giving up its “centralized and unified leadership” over financial matters by allowing foreign investors to own all the shares in banking or insurance institutions in China. Those financial institutions will still be required to have Party Committees even if they are in foreign hands, which leaves them firmly under the CCP’s control. Foreign investors who seize the “opportunity” to snap up shares in Chinese financial institutions could find themselves making the morally dubious move of “bailing out” an authoritarian regime (and indirectly funding its domestic repression and international subversion) while exposing themselves to the risk of losing all their investments should the regime suddenly decide to impose greater political control over the economy at crunch time.
2. Beijing’s relaxation of restrictions on foreign investment in China’s financial sector appears to be part of a broader set of measures aimed at mitigating financial risks and maintaining the CCP’s political power. We see at least two broad reasons why the CCP authorities have taken such a “pragmatic” move at this time.
The first reason is the CCP’s need to generate “excitement” for China and its growth prospects. The CCP authorities’ claim that China’s GDP grew by 5.2 percent in 2023 was met with plenty of skepticism, some of which we had previously covered. We also analyzed that China’s GDP could have declined by 4.7 percent last year. Our analysis has been further validated in light of more recent information. On Jan. 26, Henan Province announced that its GDP grew by 4.1 percent year-on-year to 5.9 trillion yuan. However, the province also revised its 2022 GDP from 6.1 trillion yuan to 5.8 trillion yuan after “final accounting,” which meant that the growth rate of the absolute value of Henan’s GDP was just 1.7 percent. Other provinces like Fujian, Hunan, and Jiangxi also admitted to engaging in “downward adjustments” of the respective 2022 GDP figure, which throws into question their 2023 GDP data.
The unreliability of PRC official data and increasing skepticism toward it is negatively impacting international attitudes toward China’s growth prospects. Reuters noted in a Jan. 24 piece that the CCP authorities’ efforts to boost confidence in the economy are falling flat. On Jan. 27, the Chinese edition of Deutsche Welle reported that a commentary in the German publication Die Welt had stated that the Deutsche Bundesbank is “very concerned” that the Chinese economy could decline by as much as 9 percent over the next two years.
With investors increasingly sour on China, Beijing needs to come up with something to distract them from China’s problems and focus instead on China’s “opportunities.” Relaxing restrictions on foreign investment in China’s financial sector is one such red herring intended to restore some investor confidence and attract much-needed foreign investments.
The second reason is that the CCP authorities are likely looking to have foreign investors “inherit” some of China’s pressing financial problems and risks in exchange for the “opportunity” of “fully” controlling Chinese financial institutions.
One of the problems facing Chinese financial institutions is the limited liquidity they have to acquire significant amounts of government bonds. The CCP authorities significantly stepped up bond issuance last year in the face of mounting debt problems in the localities. A Jan. 30 statement on the Ministry of Finance website disclosed that the balance of explicit local government debt in 2023 increased by 5.7 trillion yuan from a year ago to 40.7 trillion yuan. The average issuance interest rate for local government bonds in 2023 stood at 2.9 percent, resulting in interest payments soaring as high as 1.22 trillion yuan.
The central and local governments will likely continue issuing large amounts of bonds in 2024 given the lack of significant improvement in the Chinese economy. This could drain as much as 2 trillion yuan of liquidity from the markets on average each month, placing a huge strain on financial institutions. We previously analyzed (see here and here) that the CCP authorities’ attempt to roll over debt merely transfers debt risks to financial institutions and does not fundamentally resolve the regime’s broader financial troubles.
By easing restrictions on foreign investment in China’s financial sector, the CCP authorities could be hoping that foreign financial institutions will step in to provide liquidity support to Chinese financial institutions and restore some confidence in the markets.
Confidence and liquidity issues aside, the CCP authorities could also be hoping that foreign financial institutions can help with its efforts to support the private economy. With the deterioration of China’s economy in recent years, Chinese banks are seeing declining profits and have become less willing to lend to private enterprises and incur higher risks of having non-performing loans on their books. According to official data, SOEs obtain loans with an average annual interest rate of 3.8 percent while loans issued to private enterprises have an average rate of as high as 5.6 percent. The cost of financing private enterprises is also 47.4 percent higher than that of SOEs. Meanwhile, private enterprises have also become more unwilling to invest; private investment in 2023 declined by 0.4 percent even as state-owned holdings increased by 6.4 percent. As banks struggle to find qualified borrowers, substantial amounts of funds are left idling in the financial system or circulating between the banks and SOEs instead of being diverted to private enterprises.
In “opening up” China’s financial sector more broadly to foreign investment, Beijing could be hoping to encourage foreign financial institutions to utilize sophisticated risk management capabilities and find ways to extend loans to private enterprises and revitalize the private economy. This approach also allows Chinese financial institutions to offload risk to their foreign counterparts, and later even invest in asset-backed securities with comparatively lower risk offered by these foreign institutions or emulate the development of similar financial products.
3. News that the CCP authorities are considering merging the three bad debt managers into China Investment Corp. is a sign that China’s financial risks are escalating. It is likely that China Cinda, China Orient, and China Great Wall have sustained serious losses and China Investment Corp. is being roped in to “bail out” those debt managers.
Early in January 2024, Fitch and Moody’s both downgraded China Cinda, China Orient, and China Great Wall plus China Huarong. China Huarong previously suffered huge losses in 2020 and was eventually merged with CITIC Group in November 2023 and renamed as China CITIC Financial Asset Management Co.,Ltd.
News that the authorities are merging hundreds of rural lenders into regional behemoths also reflects rising financial risks.
4. The CCP authorities are unlikely to find long-term success in courting foreign investments regardless of how much it “opens up” China’s financial sector as long as several fundamental issues remain unresolved.
The greatest hurdle for Beijing is foreigners’ concerns about the domination of CCP ideology and national security over policy, as well as the regime’s divergent stance on key geopolitical issues of the day. Put another way, foreign investors will be hesitant to put money in China as long as they perceive that Beijing will choose “Xi Jinping Thought” over pragmatism in economic and financial policy, and when they fear being investigated on nebulous national security grounds. Foreign investors will also be wary of investing in China so long as the PRC refuses to denounce Russia’s war in Ukraine, abandon its goal of “reunification” with Taiwan, and align the regime with other key geopolitical interests of the U.S.-led rules-based international order.
Beijing easing restrictions on foreign investment is also unlikely to court many foreign investors over the long term given China’s worsening prospects in general. China’s demographic crisis and weakening demand are making it harder to justify greater investment in the mainland. Shrinking global demand and the “friendshoring” of manufacturing are also impacting China’s exports and cutting into a key driver of economic growth. Meanwhile, local government and real estate debt problems are only going to worsen and drag down the economy and financial sector going forward, making China less attractive as an investment destination.
Foreign investors should recognize that the risks of putting money in China now far outweigh the benefits of the “opportunity,” and should make careful adjustments to their China strategy.
