Evergrande crisis poses dilemma for China’s Communist Party regulators

China’s second-largest property developer— and the world’s most indebted real estate firm with $300 billion of liabilities—faces interest payments this week that it is struggling to make.

A growing crisis at troubled Chinese real estate giant Evergrande, that appears likely to default on interest payments this week, has posed a hard choice for regulators of China’s ruling Communist Party, as they look to contain the fallout while pushing ahead with leader Xi Jinping’s on-going crackdown on debt.

China’s second-largest property developer— and the world’s most indebted real estate firm with $300 billion of liabilities—faces interest payments this week that it is struggling to make, sparking broader concerns on the impact on China’s real estate market, a key driver of growth in the world’s second-largest economy.

While China’s authorities had many levers at their disposal to manage the debt crisis and avoid a “hard landing”, they still face a challenge, the Asian Development Bank’s Director of Macroeconomic Research, Abdul Abiad, said on Tuesday.

The Evergrande situation "warrants careful monitoring”, he said, "because housing is an important component of the Chinese economy and makes up a substantial portion of household wealth” and property sector troubles would have “knock-on effects on the broader economy”. At the same time, he said, the Chinese banking system is adequately capitalised to absorb the Evergrande shock if it materialises. The People’s Bank of China, the central bank, last week injected $14 billion into the system to address liquidity concerns.

Indeed, the background to the crisis at already debt-heavy Evergrande lies in a concerted push by Communist Party regulators, starting last August, to enforce “three red lines” to regulate the borrowings of real estate firms "by defining thresholds on liability-to-asset ratio at 70 per cent, net debt-to-equity ratio of 100 per cent, and cash-to-short-term debt multiple of more than one time”, the Hong Kong-based South China Morning Post reported. Failure to meet these targets would restrict access to loans, pushing many real estate developers to restructure starting last year as well as halt many projects.

But whether or not the Communist Party feels the need to step in to stave off a wider crisis stemming from Evergrande’s expected defaults remains unclear. State media have in recent weeks warned real estate developers to not expect bailouts, although the broader concern is the impact on China’s financial system with banks standing to lose billions of dollars.

“We don’t expect government actions to help Evergrande unless systemic stability is at risk,” S&P Global Ratings said in a research note reported by the Post. “Government support to prevent a default is only likely if contagion risks cause other large developers to fail. This could threaten the stability of the financial system and economy. We think the hit to the financial system from Evergrande alone will be manageable,” the note said.

The Communist Party will, at the same time, also be concerned by the anger of thousands of homeowners who have already paid up for homes that may now never materialise, as well as the fears of thousands of others who had purchased a range of wealth management products from the company and now face losses. Last week, around 100 angry investors gathered at Evergrande’s headquarters in Shenzhen, prompting the deployment of security personnel there. "A company as big as yours,” one of the protesters was quoted as saying by Reuters, "how much money has been swindled from ordinary people?”

(With inputs from Vikas Dhoot)

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