The Hong Kong court order to begin liquidating embattled Chinese property giant Evergrande correlates with a broader effort by Beijing to crack down on the industry and comes at a pivotal moment in its deleveraging campaign. The Hong Kong ruling could theoretically be recognized in Shenzhen, Shanghai, or Xiamen under a 2021 pilot program on liquidation rulings, although this has only been applied in one previous case. The party state only feels beholden to the rule of law when this suits its interests – and its desire to send a strong message to other property developers means it could recognize the liquidation order. But it will proceed as cautiously as it has until now.
Evergrande has been in slow-motion collapse since it first defaulted on loan payments in 2021. State-affiliated companies and banks have purchased Evergrande assets to inject liquidity and wind down the company, while shifting some unfinished projects to other developers to ensure their completion for households that made advance payments. That has helped, but with over 300 billion USD in liabilities, Evergrande is beyond saving.
At the same time, authorities have in recent years inflicted a combination of regulations and rhetoric on developers. The “three red lines”, for example, capped key financial ratios – specifically, liabilities/assets, net debt/equity, and cash reserves/short-term debt – and seriously undermined their highly risky business models. Meanwhile, President Xi Jinping’s repeated insistence that “homes are for living in, not for speculation” added an ideological element to the sector for the officials and cadres that oversee it.
It’s still unclear what exactly Beijing now will do. Not recognizing the Hong Kong ruling would broadcast that deleveraging has reached its limits and undermine foreign investor sentiment at a time when Beijing is actively courting foreign direct investment. But from a stability perspective, sentiment and property values could deteriorate considerably if Beijing recognizes the ruling, eroding what is functionally the sole asset class for middle class Chinese. That could also further burden broader financial market confidence.
All taken, Beijing will be wary of sending a weak message to property developers. Leaders will likely choose to follow the ruling and liquidate, but proceed cautiously, extending the current gradual strategy towards Evergrande to the real estate sector as a whole.
MERICS analysis: “My money is on Beijing recognizing the ruling, then doing it ‘with Chinese characteristics’ to slowly unravel the risks while clearly signaling its deleveraging campaign endures,” said Jacob Gunter, Lead Analyst at MERICS. “Xi has made it clear real estate doesn’t serve his strategic agenda and that capital needs to flow to industrial upgrading, supply chain resilience and technology. Formalizing the death of Evergrande would make that clear – and slow-walking its dismantling mitigate an acute crisis.”
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