Evergrande is not significantly more leveraged than its peers. It hit the buffers first because it relied heavily on short-term debt, like Northern Rock. “When the Three Red Lines were applied to 12 large developers last year, eight broke at least one, and four broke all three,” said Capital Economics.
“Other developers, which have a higher share of liabilities in the form of pre-sales and long-term borrowing, have so far avoided the same liquidity problems. But they too will come under growing pressure amid a deepening property downturn,” it said.
Danske Bank says Beijing will have to intervene to head off a domino effect and a severe financial crisis. But intervention can mean many things. Evergrande is the first real test case of Three Red Lines and more broadly a test of Xi Jinping’s war on “disorderly capital”. What is likely to emerge is a messy mixture that tries to decapitate and ringfence Evergrande without giving others a license to speculate.
Those who have pre-bought homes will top the creditor pecking order: largely protected in the name of social stability. The big state lenders will be cushioned by central bank liquidity. Chinese investors who sank money into Evergrande through “wealth management products” will suffer haircuts. Bondholders on the offshore dollar market can kiss goodbye to $19bn. Shareholders and foreign “tourists” will get nothing. The authorities will lean on state banks to keep lending developers enough to stay afloat.
Assuming that this storm blows over, the underlying problem remains. China has overbuilt and over-borrowed for an ageing country with a declining work-force.
“The root of Evergrande’s troubles – and those of other highly-leveraged developers – is that residential property demand in China is entering an era of sustained decline. Relaxation of regulatory controls wouldn’t change this fundamental constraint,” said Mark Williams, Asia chief at Capital Economics.