- Impending debt defaults by Evergrande are not China’s “Lehman moment”; regulators have the capability to control systemic risk.
- The more important question is whether Evergrande’s collapse will force policymakers to reverse the tightening measures designed to break the economy’s addiction to housing.
- Policymakers usually relent from property tightening measures whenever the impact on growth becomes too severe, but this time their determination appears stronger.
Not a Lehman moment
Evergrande’s potential collapse is not China’s “Lehman moment.” As previously noted, though Beijing is unlikely to provide a full bailout for Evergrande investors, regulators will act to prevent the company’s collapse from igniting social instability and systemic financial risk.
Lehman’s liabilities when it went bankrupt were equal to 4.2% of the US’ 2007 GDP, while Evergrande’s liabilities at the end of June equaled almost 1.9% of China’s 2020 GDP, according to Bloomberg. Evergrande’s balance sheet is also less complex and less interconnected with the broader financial system than Lehman’s. Evergrande’s assets are mostly land and buildings, which are easier to value and more liquid than Lehman’s derivatives and mortgage-backed securities. China’s recent history of restructurings, wind-downs, bailouts, and partial bailouts of large companies, including Anbang Insurance, HNA Group, Baoshang Bank, HFBank, and Huarong testify to Chinese regulators’ ability to contain systemic risk.
A determination to tighten
The more important question is whether Evergrande’s collapse will force policymakers to loosen tightening measures affecting the broader housing market. Restrictions on mortgage lending and developer loans have been a significant contributor to Evergrande’s distress and are also pressuring other developers. The property downturn that these measures created is severe. For the January-to-August period, new mortgage lending was RMB 1.93tn (USD 295bn) less than in the same period last year. Property sales fell 18% year-on-year in August in value terms.
Yet even as the Politburo signaled a general shift from tightening to loosening at its 30 July meeting, policymakers singled out the housing sector as an exception. The force and determination of the tightening campaign market reflects its importance to at least three distinct political objectives. The first is “common prosperity”: high housing prices are a key source of social inequality. The second is controlling financial risk: a large chunk of overall Chinese debt is collateralized with property or otherwise linked to the housing market. The third is reducing carbon emissions, which requires reducing output of construction-linked commodities like steel and cement.
The growth imperative
But these objectives stand in conflict with the need to support overall economic growth, which is slowing markedly. Housing plays an outsized role in China’s economy, including through construction, realty services, and manufacture of construction materials, home appliances and furniture. Depending on whether downstream sectors are included, estimates of the property market’s importance to GDP range from 15% to 25%.
The current round of property tightening is not unprecedented, but in the past policymakers have relented when the impact on growth became too severe. A round of property tightening in 2013-14 contributed to a sharp economic downturn in 2015-16, which in turn sparked an aggressive stimulus response in 2016. Many economists and policymakers now privately acknowledge that the 2016 housing stimulus was excessive and exacerbated long-term financial risks, in part by reinforcing moral hazard among property developers and housing speculators by convincing them government would always step back from the brink if the market fell too far.
The political calendar also played a role in the 2016 housing stimulus. The timing and force of this stimulus was likely related to President Xi Jinping’s need for a strong economy heading into the 19th Party Congress in late 2017. During the congress, Xi secured a second five-year term as Communist Party general secretary and amended the constitution to remove presidential term limits.
This time around, there are signs that the leadership’s determination to break the economy’s addiction to property may be stronger. As previously noted, in recent years Chinese policymakers have shown increased willingness to sacrifice headline GDP growth in favor of other objectives. The “common prosperity” agenda, which prioritizes quality of life, moral virtue, and social equality, is the latest example of the de-emphasis on GDP. Politically, Xi may be more confident of his position heading into the 20th Party Congress in late 2022.
But growth still matters a lot, and there is a bottom line for GDP growth beyond which policymakers will not venture. Next year’s GDP growth target may fall to 5% from this year’s target of “above 6%,” but even this lower target may be difficult to achieve. The government’s enduring commitment to a zero-tolerance policy towards Covid-19 will likely continue to force sporadic regional lockdowns, which will reduce spending on consumer services, placing more pressure on the manufacturing and construction sectors to drive growth.
The path forward
The decision on whether to persist with property tightening is not a binary one. Restrictions targeting the most expensive cities are likely to remain in place longer than those for lower-tier cities. Policymakers may loosen mortgage lending more quickly than loans to developers, since increased mortgages would deliver some relief to developers – by boosting cash flow from pre-sales – without directly increasing the financial system’s exposure to Evergrande-like companies.
Even in a scenario of maximum government tolerance for a growth downturn, the current tightening measures will not remain in place forever, so the key question is the timing and pace of loosening. In the near term, policymakers are likely to take a wait-and-see approach. In the coming months, policy may loosen incrementally if financial market turmoil worsens, other developers appear likely to follow Evergrande into deep distress, or macro data shows the economic downturn accelerating.
Overall, however, we believe that policymakers are more willing than in previous years to endure some economic pain. More substantial loosening is therefore likely to wait until early next year, when pressure on growth will likely be even stronger than today. This timeline should still enable growth to recover sufficiently to create a favorable background for Xi to secure a third term at the 2022 Party Congress.