Controlled Evergrande explosion could explode China’s economic growth model

As the Chinese real estate titan stands on the brink of collapse, there are growing fears that its ruin threatens the entire Chinese economic model.

As the crisis facing the world’s most indebted real estate company rages on, many pundits have remained cautiously optimistic that the nightmare is under control.

But there are now growing fears that the potential collapse of Evergrande may not be contained as easily as many initially thought.

And there’s a reasonable chance that it will end up breaking China’s larger growth model with it.

What is the problem?

Evergrande’s troubles began as the Chinese real estate market skyrocketed, with demand for housing in cities like Beijing and Shanghai causing prices to skyrocket.

The company took out a series of loans and grew rapidly, capturing assets and making the most of China’s booming economy.

But when house prices started to fall in small towns, and when the Chinese government put in place measures to reduce excessive mortgage borrowing, through its so-called “red line” policy, it left Evergrande on. the diamond, with mountains of debt totaling $ 408 billion.

Because the company is so massive – as China’s second-largest real estate developer, Evergrande has around 1,300 developments in 280 Chinese cities – there have been serious concerns that its demise could have a ripple effect on many Chinese cities. other industries and the economy at large, and even cause potential credit. bite.

Meanwhile, Australia also faces a relatively unique risk from the potential collapse of Evergrande, with many expecting the situation to have serious ramifications for the Chinese construction industry. This in turn will hurt Australia’s iron ore industry, which is heavily dependent on China.

“Controlled explosion”

Despite serious concern over the Evergrande saga, many economics gurus clung to the belief that the government would not let the business fail or – if it did – the threat to the economy in the sense. wide would be reduced.

But according to an alarming article by Andrew Browne of Bloomberg, Evergrande’s “controlled explosion” might not be so easily contained after all.

And Browne argues that the nightmare “could eventually blow up China’s entire model of economic growth.”

The analysis explains that China’s growth model has long been based on the “dubious” idea that housing demand is “inexhaustible”, which means that prices will always rise.

But in reality, “the flows of migrants are drying up” – a trend exacerbated but not caused by the Covid pandemic – which means there is no one to buy all these shiny new apartments.

This is a trend that is already well and truly evident, with Logan Wright, director of Rhodium Group, telling the Financial Time China had enough empty properties last week to house more than 90 million people.

“So it is highly likely that Evergrande was designed as a controlled explosion – an explosion large enough to attract the attention of other heavily indebted real estate companies headed for insolvency, but not to the point of destroying the whole. the real estate sector, and with it the Chinese economy, ”writes Browne.

“That doesn’t mean China will get away with it.”

“Systemic threat”

Although Browne and many other financial experts are not convinced that the fallout from the Evergrande fiasco will be enough to trigger a global financial crisis of the same magnitude as in 2008, he predicts that as house prices will start to decline, this will have an impact on consumption, which will slow down broader growth and prove disastrous for the entire real estate sector.

In other words, “a systemic threat is looming”.

“Beijing now faces a daunting challenge. It needs to change the engines of growth while reorganizing local governance and its entire tax system, ”writes Browne.

Impact on markets

Meanwhile, IG Australia market analyst Kyle Rodda said things were slowly improving.

“After a tumultuous week, the S&P 500 managed to make a modest gain on Friday night and end the week higher. It was expected to be an epic week last week, and it didn’t disappoint, ”he wrote in a note Monday.

“Central bank meetings were always going to attract attention. But the ongoing soap opera which is the controlled collapse of China’s Evergrande has certainly spiced things up with a little systemic risk.

“The problems with Evergrande have by no means been resolved. But despite this, and the announcement that the company has still not honored the coupon payment due last week, the risk of financial contagion is now under scrutiny by market participants.

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