Could Evergrande be China’s Lehman moment?

While most of the world’s leaders were dashing from meeting to meeting in New York, President Xi Jinping delivered an unscheduled address to the United Nations General Assembly . Apart from a warning against “the practice of forming small circles or zero-sum games” (a reference to the new AUKUS defence pact against China), the Chinese President offered only cryptic clues about his plans for the future: “China has never and will never invade or bully others, or seek hegemony.” Tell that to the Hong Kongers, the Tibetans, the Uighurs — or the Taiwanese.

The Chinese President’s typically inscrutable speech was less remarkable for what it said than what it did not. The key was the fact that his speech was prerecorded and delivered via video-link. Despite Xi’s virtual presence at the UN ’ s skyscraper in Turtle Bay, the man himself was absent. That absence was significant, because it indicates that Xi is grappling with a potentially dangerous domestic economic crisis.

Back in Beijing, the Chinese economy may be facing its Lehman Brothers moment. Evergrande, the largest property developer in China, is teetering on the brink of defaulting on more than $300 billion of debt. The risk has already sent stock markets plunging, not only in Hong Kong but on Wall Street and in Europe too.

This morning, however, Chinese and European markets rose on the news that a major subsidiary of Evergrande, the Hengda Real Estate Group, will make an interest payment on a domestic bond tomorrow. The significance of this move is not yet clear, as the sum involved — thought to be £26 million — is dwarfed by the scale of repayments due on loans worth hundreds of billions. But it is a hopeful sign that Evergrande may yet avoid defaulting on its debts.

Analysts fear that the collapse of Evergrande could have a domino effect on the highly leveraged Chinese property market, which would hit banks and other lenders. That in turn could trigger a wider economic slump across the world’s second biggest economy.

In such a worst-case scenario, the shock waves would be felt across a wide range of financial institutions in the West that are heavily exposed to China. The lessons of the 2007-2008 crisis, which began somewhat similarly with bad debts in the US real estate sector, may have been forgotten in the course of an overheated Chinese housing boom. The question now is: what will Xi do to prevent the contagion spreading?

Most China-watchers do not expect a government bailout of Evergrande. Large as it is, the failure of one corporation is not thought to pose a systemic risk. However, according to Citigroup analysts, at the end of 2020, the property sector represented over 40 per cent of the assets held by the entire banking system in China. Hence Beijing has already instructed state banks to extend repayment deadlines and write off losses. Investors must expect to take a haircut across the board — and that may include anyone in the West who relies on Chinese investors or customers here.

So far, the damage has been contained: Western stocks and shares still reflect the V-shaped post-pandemic recovery. Though China is a bigger factor than ever before in the global economy, it is still something of a mystery, at least in human terms. The statement released on Tuesday by the founder of Evergrande, Hui Ka Yan (also known as Xu Jiayin), reads more like battle orders from a general to his troops than a CEO’s letter to employees. “I believe, through joint endeavours and ardent struggles of managers at all levels and all employees, Evergrande will soon emerge from its darkest moments,” he wrote. Promising to deliver on construction targets and describing his workers as an “iron army”, he added: “Colleagues, let us unite more closely. With indomitable courage and perseverance, let’s make every effort to fulfill our social responsibilities and create a better future together.”

These words are clearly intended to be read by President Xi, too, and they tell us a great deal about the mentality that now prevails at the apex of Chinese society. Everything is seen through the prism of war and businesses are expected to be run with military discipline. The rewards are huge — until Evergrande ran into trouble, Hui was probably the richest man in China. But those who fail to live up to their “social responsibilities” can expect no mercy. Corruption charges can be trumped up and billionaires can vanish overnight, perhaps only resurfacing months later to be sentenced to long prison terms — if they are lucky. The only way to avoid execution is to plead guilty; their assets will be confiscated in any case. Nobody is ever acquitted.

This is a business environment so alien to that of Europe or North America that it is questionable whether words like “capitalism” are still meaningful when applied to China. Entrepreneurs are seen as officers in a state-led national campaign, more akin to the Maoist mythology of the “Long March” or the “Great Leap Forward” than to the normal evolution of a market economy. Collective goals, set by the leadership of the Communist Party, are still of paramount importance. Xi undoubtedly sees himself as a successor to the Great Helmsman. He may see the containment of the coronavirus, at least as far as China is concerned, as a model for containing the fallout from Evergrande. The global crisis caused by Covid, which began in Wuhan and was initially concealed on Xi’s orders, has paradoxically added to his power and prestige. Economic crises, however, are beyond the control of even one-party states. It will be fascinating to observe how the politics of pandemic morph seamlessly into the politics of a property market crash. This could be the moment when China’s apparent ability to defy economic gravity comes to an abrupt end. Everything depends on the skill with which this property bubble is deflated — perhaps even the hitherto unchallenged authority of Xi himself.

In the past, it was the ordinary people who paid the price for incompetence at the top. Mao’s Great Leap Forward was meant to modernise China’s agrarian economy, transforming it into an industrial one, but the Communist utopia turned into a genocidal dystopia: more than 50 million starved to death. Today’s China may bear little resemblance to the famine-stricken land of the 1950s, but it is in many ways more totalitarian than ever before. Xi’s digital surveillance state enjoys an unprecedented degree of control of a population whose undreamt-of wealth can be channelled into an equally unprecedented military buildup. But Evergrande is a reminder that not even the most perfect oriental despotism lasts forever.

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