How does China fix the Evergrande mess?

The Chinese property developer Evergrande owes more than $325bn (£269bn). That’s more than Russia’s entire national debt.

For two years, the company has been lurching from crisis to crisis, repeatedly failing to make payments on its multi-billion dollar loans.

Now its billionaire chairman is under police surveillance, its shares are practically worthless and more than a million people in China are still waiting for their homes to be completed. On Monday, a court in Hong Kong could open a new chapter in the crisis by ordering the liquidation of some of Evergrande assets to pay back frustrated foreign investors.

Evergrande has become the poster child of China’s flailing real estate sector. Its name, along with other major developers such as Country Garden, has become associated with unsustainable debt and impending financial disaster. Yet, Evergrande clings to survival.

In most Western countries, a failing privately-owned business such as Evergrande would either be liquidated or, in extreme cases, bailed out by the government. But things are done differently in China.

The world’s second-largest economy is neither capitalist nor communist. It is unique, which makes it hard to predict Evergrande’s fate.

But for now, Beijing has eased pressure on the firm in ways other countries cannot.

“It’s alive only because the government hasn’t let it die,” says Leland Miller, chief executive of China Beige Book, an analytical platform that tracks the Chinese marketplace.

Unlike Western countries, China is not a free market. When a problem arises, Mr Miller explains, the state can simply move tidal waves of money to patch it up.

The majority of the money Evergrande owes is to creditors in China, including ordinary homeowners, suppliers and banks. And the government’s control over them is key to explaining the company’s zombie-like state.

“The banking system in China is still almost exclusively state-run,” says Dexter Roberts, senior fellow at the Atlantic Council. “So if Beijing tells those banks to find a way to roll over the debt, then they’re going to do that. Ultimately, they answer to the state and they’re well aware of that.”

Mr Miller agrees: “The Chinese state can order lenders to lend, suppliers to supply, borrowers to borrow. Evergrande is neither dead nor alive, but in this system it doesn’t really matter.”

Not all of Evergrande’s creditors are Chinese. A small group of frustrated lenders outside of China have scheduled a court hearing in Hong Kong on 30 October. A judge could order a liquidation of company assets to be distributed to these foreign creditors.

However, this would be unprecedented in scale and complexity. And it would almost certainly need the approval of Chinese authorities.

So what happens to Evergrande? Some analysts say that China’s leadership is yet to decide.

“A lot of the Chinese system is still modelled on the Soviet Union and there were no bankruptcies in the Soviet Union,” says Logan Wright, director of China Market Research at Rhodium Group.

“You have to remember that Western capitalism has had a long time to establish a process for failed companies and how you manage their debts. In China, there isn’t the same kind of template.”

The Chinese government could let Evergrande collapse. But, according to Mr Roberts, Beijing would then have to clean up the mess, which would be a huge political headache.

The knock-on effects for local governments – which rely on land sales – suppliers and banks would be “potentially catastrophic”, he added.

Other analysts argue that Evergrande’s collapse, if it were to happen, could hurt the future of the Communist Party itself.

“Social stability is at stake,” says Shitong Qiao, an expert in Chinese property law at Duke University in the US.

“A collapse would not just leave many Chinese banks with bad debt, it would also leave hundreds of thousands of Chinese homebuyers without an apartment that they have paid for.”

On more than one occasion, there have been chaotic scenes at Evergrande’s headquarters in Shenzhen, when protesters scolded executives and home buyers demanded refunds on their purchases. Last year, many of them joined a mortgage strike until their homes were completed.

A collapse could shatter confidence in the housing market, plunging prices further. That would leave people noticeably poorer in a country where they invest their life-savings in new homes. And it would be a blow to an already sluggish economy – the property sector accounts for a quarter of it.

All of this could lead to more public anger and even instability. And that is perhaps the biggest threat to the Party, whose grip on power has long been bolstered by China’s prosperity.

Does that mean Evergrande is – to borrow a Western phrase – “too big to fail”.

It is tempting to draw parallels with the subprime mortgage crisis in 2008, which saw the collapse of Wall Street investment giant Lehman Brothers and a global recession. Back then failing banks and institutions around the world were bailed out by their governments and central banks.

But China is different. Its financial system is not as enmeshed with the property sector as it is in the US.

And Beijing, which has firm control over money flows, seems in no rush to bail out Evergrande.

“The system is designed to ensure that an acute crisis will always be very unlikely,” Mr Miller says. “It’s not susceptible to a western-style ‘Lehman moment'”.

A bailout would also not fit with the ideology of China’s leadership. In fact, some argue that the Party deliberately triggered Evergrande’s decline because the firm’s success relied on a flawed economic model.

Evergrande’s rise was fuelled by heavy borrowing to build houses for middle-class Chinese looking to make money from property. But property developers borrowed too much money to build too many houses that not enough people want to buy.

“This is not a sustainable economic model and the government knew this,” Mr Roberts says.

This “investment-led growth” – or building for building’s sake – drove China’s rise well before Xi Jinping came to power in 2012.

But over time the Party’s refrain, encouraged by Mr Xi, became “houses are for living in, not for speculation”.

Things came to a head in 2020 when the government, fearing a bubble in the property market, introduced new financial regulatory guidelines, known as its “three red lines”.

They severely restricted developers’ ability to borrow more money, eventually causing the crisis that has mired Evergrande and the rest of China’s property sector.

For China’s leaders, the painful but necessary measure was the only way to rein in unsustainable debt. Except they didn’t anticipate how much worse it would get, especially as China’s economy took a hit from sweeping zero-Covid lockdowns.

“But still, bailing out Evergrande now would effectively make a mockery of everything the government is trying to do in terms of de-leveraging the sector and changing the economy,” Mr Roberts says.

Mr Wright agrees it would be seen as a backward step: “What kind of signal are you sending to the rest of the industry if you bail out Evergrande?”

In other words, China’s leadership is stuck. A collapse would be disastrous and a bailout would be ideologically untenable.

“This may be a contrarian view – but I absolutely believe Beijing has a strategy here,” Mr Miller says.

“For years foreign investors have lectured Beijing that it needs to stop relying on artificially high levels of growth driven by property sector borrowing. Now that the Party is finally doing that – it was never going to be a painless process.”

What new model Mr Xi, who has increasingly centralised power in his hands, wants is unclear.

At last year’s Party Congress, when he secured a historic third term as leader, he warned against continuing China’s “unsustainable” economic model, driven by what he calls “money worship” and “vested interests”. Rebuking the dangers of unfettered capitalism, he said: “The leadership of the Communist Party of China is the defining feature of socialism with Chinese characteristics.”

Amid the chaos of Evergrande, the arrest of its billionaire founder and chairman Hui Ka Yan reinforced the idea that the Party, rather than private businessmen, is still firmly in charge.

According to Mr Miller, China is consciously paying the price for “gross economic mismanagement”, but its continued grip over the economy suggests it has a plan.

But others insist that is not so clear.

“Capitalism is a profit and loss system,” Mr Wright says. “It will be interesting to see how China deals with the losses part”.