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Twist in Evergrande’s ‘controlled explosion’

As the Chinese property titan teeters on the brink of collapse, there are growing fears its ruin could threaten China’s entire economic model.

As the crisis facing the world’s most indebted real estate company rages on, many experts have remained cautiously optimistic that the nightmare was under control.

But there are now growing fears that Evergrande’s potential collapse won’t be able to be contained as easily as many initially believed.

And there’s a reasonable chance it could end up shattering China’s wider growth model along with it.

What’s the problem?

Evergrande’s troubles began as China’s real estate market soared, with demand for homes in cities such as Beijing and Shanghai sending prices skyrocketing.

The company took out a string of loans and expanded rapidly, snapping up assets and making the most of China’s thriving economy.

But when property prices began to drop in smaller cities, and when the Chinese government rolled out measures to curtail over-the-top property borrowing, via its so-called “red lines” policy, it left Evergrande in the lurch, with mountains of debt totalling a whopping $408 billion.

Because the company is so massive – as China’s second largest property developer, Evergrande has around 1300 developments across 280 Chinese cities – there have been serious concerns its demise could have a spillover effect on other industries and the wider economy, and even cause a potential credit crunch.

Meanwhile, Australia is also facing a relatively unique risk from the potential Evergrande collapse, with many expecting the situation to have serious ramifications for China’s construction industry. This in turn will hurt Australia’s iron ore sector, which is heavily reliant on China.

‘Controlled explosion’

Despite serious alarm over the Evergrande saga, many economic gurus have clung to the belief the government wouldn’t let the company fail or – if it did – the threat facing the wider economy would be curtailed.

But according to an alarming article by Bloomberg’s Andrew Browne, Evergrande’s “controlled explosion” might not be so easily contained after all.

And Browne argues the nightmare “may eventually blow up China’s entire economic growth model”.

The analysis explains that China’s growth model has long been based on the “doubtful” idea that demand for real estate is “inexhaustible”, which means prices will always rise.

But in reality, “migrant flows are drying up” – a trend exacerbated but not caused by the Covid pandemic – which means there’s nobody to buy all those shiny new apartments.

It’s a trend that’s already well and truly evident, with Rhodium Group director Logan Wright telling the Financial Times last week China had enough empty property to house more than 90 million people.

“It’s quite likely, then, that Evergrande was intended as a controlled explosion – one big enough to get the attention of other highly indebted real estate firms headed toward insolvency but not so big as to take down the entire property sector, and with it the Chinese economy,” Browne writes.

“That doesn’t mean that China will escape unscathed.”

‘Systemic threat’

While Browne and many other financial experts aren’t convinced the fallout from the Evergrande fiasco will be enough to trigger a global financial crisis on the same scale as 2008’s, he predicts that as property prices start to drop, it will impact consumption, which will slow down wider growth and prove disastrous for the overall property industry.

In other words, “a systemic threat is looming”.

“Beijing now faces an awesome challenge. It must shift the drivers of growth while re-engineering local governance and its entire fiscal system,” Browne writes.

Impact on markets

Meanwhile, IG Australia market analyst Kyle Rodda said things were slowly looking up.

“After a tumultuous week, the S&P 500 managed to eke out a modest gain on Friday night and close out the week higher. It was expected to be an epic week last week, and it didn’t disappoint,” he wrote in a note on Monday.

“Central bank meetings were always going to garner attention. But the unfolding soap opera that is the controlled collapse of China’s Evergrande certainly spiced things up with a little systemic risk.

“The problems revolving around Evergrande have by no means been addressed. But despite that, and news that the company still hasn’t honoured a coupon payment due last week, the risk of financial contagion is being looked through now by market participants.”

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