The Fall of a Giant: How Evergrande’s Liquidation is Impacting China’s Economy
Photo By: Florian Wehde
In late January, a Hong Kong court mandated China’s largest real estate developer, the Evergrande Group, be liquidated, marking the end of a blockbuster 19-month hearing. Evergrande, holding the dismal title of the world's most indebted property developer, failed to convince the court of a tangible restructuring plan and was subsequently ruled insolvent. Though the firm's borrowing woes began years ago, it was only in 2020 that Chinese regulators began to curtail excessive borrowing by real estate companies. By 2021, the property giant defaulted on over $300 billion USD worth of debt – the beginning of China’s real estate crisis.
Evergrande’s story began over two decades ago, during a historic demographic shift. China saw its urban population increase from 172 million people in 1978 to 882 million people in 2022, an increase that brought a drastic uptick in demand for affordable housing with it. This migration was rooted in a desire for new economic opportunities, as household income in the countryside remained comparable to figures preceding even Mao Zedong’s regime from 1949-1978. Property firms capitalized on the population boom, with groups like Evergrande building up urban centers in order to accommodate China’s rapidly growing middle class.
This influx of capital allowed Evergrande to greenlight an array of ambitious projects, many of which proved to be shortsighted. Unchecked and risky investment practices, incessant borrowing, and inept upper-level leadership plagued Evergrande, drawing comparisons to the failure of Lehman Brothers in 2008. Prior to its collapse, Lehman Brothers was the fourth largest investment bank in America, but engaged in reckless corporate strategies like gross overleveraging without adequate financial backing and a culture of rewarding brazen risk takers. Similarly, Evergrande utilized hazardous levers such as the presale system, which involved home buyers making advance payments, often in full, prior to the construction of their residences. Evergrande allocated those funds into separate projects while taking on further debt, leaving home buyers without their promised housing for prolonged periods of time. Another factor that influenced Evergrande’s precarious strategy was the competitive nature of China’s real estate market. With several players competing for investment from foreign firms, there were greater incentives to move from project to project quickly, typically with marginal consideration for the broader market impact.
The effects of Evergrande and other firms' negligent practices were fully realized by China’s central government in 2020, leading to significant reform measures. These regulations, dubbed the “Three Red Lines,” imposed three barriers to accessing new debt: liabilities should not exceed 70 percent of assets, net debt should not be greater than 100 percent equity, and money reserves must be at least 100 percent of short-term debt. Despite these efforts, substantial damage had already been done to the real estate sector, as China currently possesses one of the world’s worst housing affordability indexes at a startling 0.4, with the average mortgage costing 259.4 percent of annual household income. The housing affordability index measures a household's ability to qualify for a mortgage loan based on its annual income and has China ranked as the 93rd least affordable country out of 105 documented countries. Furthermore, the product of fierce competition between property groups resulted in about 30 million unoccupied residences, estimated to be capable of housing 80 million Chinese citizens. That is a figure that exceeds the total population of economic powerhouses such as France, the United Kingdom, and Germany.
Additionally, Evergrande’s bankruptcy has drastically affected markets outside of the real estate sector, notably in the financial sphere. Since housing reform began in the late 1990s, property has become widely recognized as the premier option for personal investment. One explanation for this confidence is based on the belief that China’s central government would never allow such an influential driver of their economy to fail, once again echoing sentiments from the 2008 Financial Crisis. Over two thirds of total household assets resided in real estate as of 2021, making China’s recent economic turmoil even more concerning to the middle class. Matters reached a boiling point in 2023 when the Zhongrong Trust, a large wealth management firm with over $10 billion USD worth of investor funds sunk into the property market, failed to make principal and interest payments to its investors. Trust in financial institutions has faded, as was proven by an aggravating 80 percent increase in household savings during 2023.
In such an interconnected global environment, China’s property woes and subsequent economic turmoil have had troubling effects on international economic integration. Foreign direct investment, once a stalwart of China’s developing economy, has fallen to $180.17 billion USD in 2022, a 47.64 percent decline from 2021. This dramatic shift signifies a commonly held lack of faith in China’s economic rebound, leaving monetary experts skeptical regarding the outlook for global economic growth. China’s economic downturn is one of many notable factors, including trade fragmentation, conflicts in Ukraine and the Middle East, and monetary policy restrictions, that have led the World Bank to forecast 2024’s global GDP growth at a meager 2.4 percent.
Consumption failed to demonstrate itself as an immediate alleviating factor for China’s economic lag, forcing central leadership to explore new avenues of growth. Chinese Communist Party President, Xi Jinping, has hinted at remedies such as renewable energy innovation and an increase in exports, possibly through the Belt and Road Initiative, but these projects come with their own shortcomings. The Belt and Road Initiative has received staunch pushback from involved countries, as foreign perception has shifted to that of neocolonialist intent on China’s behalf. Renewable energy has increased from 7.2 percent to nine percent of China’s total GDP in 2023, but that figure pales in comparison to the property sector's former contribution. China also remains the world's largest polluter, outpacing the United States’s carbon emissions by 215 percent in 2023.
As the dust settles on China's real estate sector, the global economy awaits the Chinese Communist Party's next move. With property once at the core of Xi Jinping’s domestic economy, fueling China’s miraculous growth into the 21st century and contributing over 18 percent to global GDP in 2023, the faltering real estate market poses a daunting challenge to global economic stability. As China's economic forecasts shrink from an anticipated five percent in 2024 to a mere 3.5 percent in 2028, marking the most significant decrease since the late 1980s, identifying a new, resilient engine of growth becomes critical. This alternative path must be less vulnerable to external shocks and more sustainable than the exorbitant borrowing model that characterized its property boom, ensuring that China's exponential rise remains a key factor in global GDP growth. The world demands a lasting resolution from the Chinese Communist Party, not just for China's economy but for the continued prosperity of the global economy as well.