What happened

This week, a Hong Kong court ordered Chinese real estate developer Evergrande to be liquidated. After Evergrande had defaulted on its dollar debt for the first time in 2021, the Hong Kong lawsuit was initiated by a creditor in mid-2022. The verdict was the outcome of this lawsuit, sealing the fate of Evergrande at least internationally.

 

Why it matters

Evergrande was once one of the world’s largest real estate developers. It is also one of the largest debtors with commitments amounting to $300 billion. This means that the sheer size of Evergrande and its debt have the potential to shake financial markets.

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However, even more importantly, a large part of Evergrande’s debt is held within Mainland China. Additionally, most assets of Evergrande are located there, too. This means that the bulk of the liquidation would have to happen within China itself. What is at stake for the Chinese government is not simply the question of good economic policy but also the credibility of its legal system, the recognition of Hong Kong and legal decisions made there and, most importantly, the overall legitimacy of the Chinese Communist Party itself. The order to liquidate Evergrande has the potential to send shockwaves through the Chinese political and economic system on a number of different levels.

 

What to take away

The Chinese government is in an uncomfortable position. After the liquidation order from Hong Kong, they face two problems at the same time.

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First is the issue of trust. Normally, enforcing a court judgement on the liquidation of a company should be a no-brainer and instil trust in investors that they will get at least some of their money back in case of bankruptcy. However, there are no signs that the Chinese government intends to enforce the Hong Kong court judgement and simply liquidate Evergrande within China. Shortly after the liquidation order, Evergrande representatives emphasised that the part of the company listed in Hong Kong is legally separate from Evergrande’s operations on the mainland. In other words, it is unlikely that the liquidation will be directly enforced on the mainland. This means that international creditors are also unlikely to recover a lot of their assets through the liquidation of the company. This will certainly not increase trust in international investors to lend large sums of money to companies in China again.

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At the same time, the Chinese government has to deal with an even thornier domestic issue: the amount of domestic Chinese wealth being tied up in Evergrande. Most assets of Evergrande are in Mainland China. This includes a four-digit number of housing projects in China that have only been partially or not at all completed. While the Chinese government is unlikely to bail Evergrande out and pay off its international debt, domestically, it cannot just let the company go under. A lot of Chinese have invested their wealth in real estate and made upfront payments for apartments with Evergrande. The Chinese government cannot afford to simply let Evergrande default on this if it is anyhow concerned about its own legitimacy and social stability within the country. This is certainly the Party’s biggest concern right now.

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There are indeed indications that the Chinese government is planning to throw significant resources at this issue. In the Chinese-language Chinese media, the liquidation order has not been widely reported on, indicating that the government intends to downplay the issue. Rather, in the state media, positive news about the real estate sector dominate and report, for example, on how much investment in the Shanghai property market has grown over the past year. Additionally, positive news on the state of the Chinese economy appear both in Chinese and English language Chinese media. Additionally, the Chinese government has already started releasing funds into the real estate sector to ensure that at least projects that consumers already paid for will be completed. All this hints at the Chinese government attempting to downplay the issue and trying to diffuse any cause for alarm domestically.

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The way this might work is through a nominal separation of Evergrande internationally and domestically. Evergrande already indicated that its business on the mainland will continue for now as a separate legal entity. If this line is followed through, then the Chinese government will probably look at dissolving Evergrande on the mainland in a very slow and orderly manner while restructuring and maintaining its construction commitments. This is not going to be a fast process and it will potentially cost the Chinese state a lot of money. However, for the Communist Party and the Chinese government, this is a better option than to simply wrap up Evergrande’s construction projects on the mainland and in the process destroy the savings and investments of a many middle-class Chinese. Angering the middle class would be the Party’s worst-case scenario.

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In terms of overall economic impact, this basically means two things. Firstly, an immediate massive shock effect on domestic and international financial markets did not occur and is unlikely to occur at this stage. The liquidation order only confirmed what most investors were aware of anyway: that Evergrande at this stage is largely worthless.

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In the long term, however, the Evergrande meltdown is likely to put further downward pressure on the Chinese economy. While the Chinese government will try to avoid the pulverisation of personal savings of individual Chinese in the Evergrande collapse, it will have to throw significant amounts of money at cleaning up the mess. In an economy still significantly driven by investment rather than consumption, this puts pressures on the government and public finances. This is where we are more likely to see the effects of Evergrande’s collapse: in additional longer-term pressure on public finances and economic growth.

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