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Analysis-For Xi and China Evergrande, a delicate balancing act By Reuters

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© Reuters. FILE PHOTO. A vehicle passes the Evergrande Cultural Tourism City construction site in Suzhou, Jiangsu, China, September 23rd, 2021. REUTERS/Aly Song/File Photo

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By Andrew Galbraith

SHANGHAI (Reuters) – The crisis at property giant China Evergrande Group poses a $305 billion conundrum for President Xi Jinping: how to impose financial discipline without fuelling social unrest.

One year is left before China’s president secures a third 5-year term. This is the most important period in his presidency.

Evergrande’s borrow-to build model was enabled because a government dependent on property sales for revenues and unwilling to face runaway indebtedness fearing that a collapse of prices could have catastrophic consequences for a nation in which 40% of the country’s wealth is owned by property.

Xi is the man who unleashed a slew of social and industry reforms to promote “common prosperity”, but he has stressed that it’s time for a halt to decades of unsustainable growth and unsustainable debt.

But shared responsibility for Evergrande’s crisis – and worries about the repercussions of a messy collapse – complicate decisions on the fate of a conglomerate with $305 billion in debt that is scrambling to pay creditors, including bondholders owed $83 million in a coupon payment https://www.reuters.com/world/china/china-evergrande-bondholders-limbo-over-debt-resolution-2021-09-24 that was due on Thursday.

Andrew Collier from Orient Capital Research stated that “the government has to some extent caused the problems in Evergrande.” He cited the 2020 debt ratio caps known as the “three Red Lines”, which put Evergrande at significant risk and forced the company to sell off assets.

These caps were in response to renewed concern by officials last year about the property sector’s froth. This was after increased sales and indications of developers’ speculative overbuilding led to monetary easing.

Due to its fiscal dependency, it is not easy to reduce property prices. Orient Capital has estimated that 89% of all government spending is derived from local governments. This codependence with developers drives land sales to the extent that they account for 40% of overall revenues.

Fraser Howie is the author of several books on China’s financial system.

DEEP ROOTS

The roots of the crisis date to tax reforms in 1994, which bolstered central government coffers but left local governments reliant on land financing for revenue, said Alfred Wu, associate professor at Lee Kuan Yew School of Public Policy in Singapore.

It led to an increase in property values and the rise of Evergrande developers, who thrived in fourth and fifth-tier cities.

Regional governments see Evergrande as a money cow. If the company is bankrupt, regional governments, as well as the land-financing model, will be affected. Wu claimed that Wu was not allowed by the central government to allow such a thing.

Even though Evergrande was warned about its business model by many quarters for decades, such as taking on large amounts of debt to help land and other acquisitions, Evergrande proved not to be a rebel operator.

Hui Ka Yan, majority shareholder and chairman of the company, took great pains to highlight his strong alliance with Beijing’s ruling Communist Party and showed it off. This was then reciprocated.

Hui is listed as a “national model worker”, a poverty fighter, and an “Excellent builder for the socialist cause with Chinese characteristics” in Evergrande’s 2020 Annual Report.

GREAT AWAKENING

Stability-obsessed Beijing is well aware that the rise in the housing market created not only great wealth but deep inequality.

A portfolio manager from outside China, who refused to identify himself, said that the anti-government protests of 2019 in Hong Kong were partly due to rising inequality and sky-high housing prices.

Analysts said that Xi is attempting to transform the “three great mountains” of education, housing and healthcare in order to curb rising costs to city dwellers to maintain his legitimacy as “people’s leader”.

Discontent among investors, home buyers, and suppliers last week showed discontent that could escalate in the case of defaults at other developers.

UBS has estimated that there are 10 potentially hazardous developers accounting for 1.86 trillion Yuan ($287.92 Billion), almost three times Evergrande.

Analysts believe there is no wider crisis. Many predict authorities would pursue a strategy of seizing the whole property sector, while simultaneously addressing specific problems as they occur.

Tang Renwu of Beijing Normal University, School of Public Administration, said that Evergrande’s bankruptcy could result in social instability. He explained that disgruntled shareholders and homeowners could make Evergrande unmanageable. Large layoffs may increase unemployment and cause financial risks.

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