China’s Rising Debt Problem Reveals Systemic Weakness

News AnalysisWhile commentators obsess about American weakness and worry about how Russia and China will divide up the world, China has its own problems, primarily an ever-growing burden of unpayable debt. It revealed itself first with the property developer Evergrande, but when that firm’s debt problems hit the headlines last spring, Beijing had to have known that the list of firms with problem debt would grow. And indeed, the list of insolvent development companies has increased, making China’s financial system increasingly fragile. On a deeper level, the circumstance reveals a fundamental weakness in China’s top-down, planned approach to economic management. The latest company to announce its inability to service its outstanding debt is the developer Yango Group Co. In January, the firm had staved off default by swapping $670 million in existing bonds into new debt instruments. It took only a matter of weeks for the firm’s management to announce that it was still unable to meet its obligations. As in the way of a troubled financial system, that failure has driven Yango Group’s biggest shareholder, Fujian Yango Group Co., to miss an interest payment on some $296 million in debt. Along with this trouble, the China Aoyuan Group has also announced that it cannot meet its financial obligations. These sad announcements follow the earlier news about defaults at Evergrande, as already mentioned, Kaisa Group Holdings Ltd. and Fantasia Holdings Group Co. An informal count indicates that some 40 percent of the $6.3 billion of old bonds swapped for new are already in default. A sign of the Kaisa Plaza, a real estate property developed by Kaisa Group Holdings, is seen near its apartment building in Beijing, China, on Dec. 1, 2021. (Tingshu Wang/Reuters) Large as they are, these actual default figures constitute only a small part of the monies at risk. As was well-publicized when the news on Evergrande first broke, there are doubts that the company can discharge about $300 billion in liabilities. All these other companies add to that amount. There is now a clear indication that all developers may be in difficulty, not a small matter since property development amounts to about a third of China’s economy. More urgent—for both bondholders and those in Beijing charged with protecting the health of Chinese finance—is the huge volume of bonds set to mature soon. According to the Anglo-American data and consulting firm, Refinitiv, Chinese real estate developers will face some $117 billion in maturing debt in 2022, almost a third of that denominated in dollars. Some $27 billion will mature in weeks. The government in Beijing and media outlets—both Chinese and Western—have so far laid the blame for these debt problems on the profligacy of Chinese developers. There can be little doubt that many of these firms had flamboyant managements that borrowed too heavily and spent too freely. Stories about how Evergrande bought a sports team and flew it around the world in private jets have recurred in many media treatments of the matter. But if imprudent management can take some of the blame, the lion’s share belongs to policymakers in Beijing. For decades, almost since China’s great opening in the late 1970s, property development has held pride of place in the nation’s growth model. Beijing used special bonds to encourage provincial governments to work with private developers to raise whole cities from what were farmers’ fields. These rapid developments formed the basis of glowing Western media reports and continued to do so into the second decade of this century. Little wonder that property development grew to such a large part of China’s gross domestic product (GDP). All this growth required debt—taken on first by provincial and local governments through the special bonds authorized by Beijing and then by the developers who understandably expected no end of contracting monies for these real estate projects. Having gone on for decades, the borrowing and spending have become so excessive that some 20 percent of China’s housing stock is unoccupied today. This portion has neither been sold nor does it return a rent. And since government contracts have stopped flowing simultaneously, it is a small wonder that developers cannot pay off some of the mountain of debt they accumulated over the years. Cranes stand next to unfinished residential buildings at the Evergrande Oasis, a housing complex developed by Evergrande Group in Luoyang, China, on Sept. 15, 2021. (Carlos Garcia Rawlins/Reuters) This situation is dangerous and not just because some real estate developers will pass from the scene. The bigger problem lies with the many lenders—Chinese and foreign—that will find themselves stuck with worthless or deeply discounted bonds. They will have less ability to support future development than had this great waste not occurred. Perhaps worse still, no one will know who these injured financial actors are, and so others will

China’s Rising Debt Problem Reveals Systemic Weakness

News Analysis

While commentators obsess about American weakness and worry about how Russia and China will divide up the world, China has its own problems, primarily an ever-growing burden of unpayable debt.

It revealed itself first with the property developer Evergrande, but when that firm’s debt problems hit the headlines last spring, Beijing had to have known that the list of firms with problem debt would grow. And indeed, the list of insolvent development companies has increased, making China’s financial system increasingly fragile.

On a deeper level, the circumstance reveals a fundamental weakness in China’s top-down, planned approach to economic management.

The latest company to announce its inability to service its outstanding debt is the developer Yango Group Co. In January, the firm had staved off default by swapping $670 million in existing bonds into new debt instruments. It took only a matter of weeks for the firm’s management to announce that it was still unable to meet its obligations.

As in the way of a troubled financial system, that failure has driven Yango Group’s biggest shareholder, Fujian Yango Group Co., to miss an interest payment on some $296 million in debt. Along with this trouble, the China Aoyuan Group has also announced that it cannot meet its financial obligations.

These sad announcements follow the earlier news about defaults at Evergrande, as already mentioned, Kaisa Group Holdings Ltd. and Fantasia Holdings Group Co. An informal count indicates that some 40 percent of the $6.3 billion of old bonds swapped for new are already in default.

Epoch Times Photo
A sign of the Kaisa Plaza, a real estate property developed by Kaisa Group Holdings, is seen near its apartment building in Beijing, China, on Dec. 1, 2021. (Tingshu Wang/Reuters)

Large as they are, these actual default figures constitute only a small part of the monies at risk. As was well-publicized when the news on Evergrande first broke, there are doubts that the company can discharge about $300 billion in liabilities.

All these other companies add to that amount. There is now a clear indication that all developers may be in difficulty, not a small matter since property development amounts to about a third of China’s economy.

More urgent—for both bondholders and those in Beijing charged with protecting the health of Chinese finance—is the huge volume of bonds set to mature soon. According to the Anglo-American data and consulting firm, Refinitiv, Chinese real estate developers will face some $117 billion in maturing debt in 2022, almost a third of that denominated in dollars. Some $27 billion will mature in weeks.

The government in Beijing and media outlets—both Chinese and Western—have so far laid the blame for these debt problems on the profligacy of Chinese developers. There can be little doubt that many of these firms had flamboyant managements that borrowed too heavily and spent too freely.

Stories about how Evergrande bought a sports team and flew it around the world in private jets have recurred in many media treatments of the matter. But if imprudent management can take some of the blame, the lion’s share belongs to policymakers in Beijing.

For decades, almost since China’s great opening in the late 1970s, property development has held pride of place in the nation’s growth model. Beijing used special bonds to encourage provincial governments to work with private developers to raise whole cities from what were farmers’ fields. These rapid developments formed the basis of glowing Western media reports and continued to do so into the second decade of this century.

Little wonder that property development grew to such a large part of China’s gross domestic product (GDP). All this growth required debt—taken on first by provincial and local governments through the special bonds authorized by Beijing and then by the developers who understandably expected no end of contracting monies for these real estate projects.

Having gone on for decades, the borrowing and spending have become so excessive that some 20 percent of China’s housing stock is unoccupied today. This portion has neither been sold nor does it return a rent. And since government contracts have stopped flowing simultaneously, it is a small wonder that developers cannot pay off some of the mountain of debt they accumulated over the years.

Evergrande Oasis housing complex developed by Evergrande Group, in Luoyang
Cranes stand next to unfinished residential buildings at the Evergrande Oasis, a housing complex developed by Evergrande Group in Luoyang, China, on Sept. 15, 2021. (Carlos Garcia Rawlins/Reuters)

This situation is dangerous and not just because some real estate developers will pass from the scene. The bigger problem lies with the many lenders—Chinese and foreign—that will find themselves stuck with worthless or deeply discounted bonds. They will have less ability to support future development than had this great waste not occurred.

Perhaps worse still, no one will know who these injured financial actors are, and so others will hesitate to lend or invest for fear that one or more of the parties involved are weakened from bad debt holdings. There may be a benefit in that such worries will introduce needed prudence into the system, but it also means that the pace of financial dealing will slow and, consequently, the rate of economic growth.

This bad debt problem reveals yet another weakness in Chinese economics. The gross real estate overbuilding stems from the nature of China’s centrally planned approach to economic decision-making. The excess of debt and housing directly results from planners’ inability to see that Chinese people had different living needs than the planners had thought.

Why would they fail to see this?

Unlike a business dealing directly with buyers, the planners have no contact with the people for whom they plan. From the planners’ point of view, such development had worked in the past and should continue to do so. As long as Beijing pushed it, provincial governments and developers had every reason to go along.

In a more market-based approach, all involved would have seen that the demand for such housing was not there and backed away a lot sooner than the Chinese planners did. The overbuilding and the debt overhang would have been a lot less severe.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.


Follow

Milton Ezrati is a contributing editor at The National Interest, an affiliate of the Center for the Study of Human Capital at the University at Buffalo (SUNY), and chief economist for Vested, a New York-based communications firm. Before joining Vested, he served as chief market strategist and economist for Lord, Abbett & Co. He also writes frequently for City Journal and blogs regularly for Forbes. His latest book is "Thirty Tomorrows: The Next Three Decades of Globalization, Demographics, and How We Will Live."