Many Western media and analysts have hypothesized that the Evergrande case could represent a “Lehman moment” for China, the catalyst for an economic and financial crisis in the Chinese system, with repercussions also abroad. Fortunately for us, these analysts are wrong and forget that, in China, the financial system is structured differently from ours and that the primary objective of the Chinese government is to maintain the country’s socio-economic stability.
In these days, finding myself in China, I had the opportunity to meet representatives of various institutions and even ordinary citizens involved in this crisis: both segments of society, some at the top because they are more informed of the facts, some at the bottom because they simply hope and trust. in their own government, they agree that the Chinese government will do everything to avoid any systemic effect.
Evergrande, no to default but shareholders and funds will pay
The scenario that seems most likely to me today is that of the subdivision into good and bad company, a possible stew of the good company among other operators in the sector “encouraged” by the government, such as banks and developers, and, as it was during the banking restructuring of 1990s under Prime Minister Zhu Rongji, it is hoped that strong GDP growth will sweep debt under the rug.
The government will avoid systemic risk because society asks it, even the humblest of savers. Unlike our political systems, the stability of the country in China is a function of the consensus that the Communist Party gets from the population. It seems a paradox, but while in Italy the intolerance towards a party can materialize in the variations of consensus from one party to another and the stability of the country is guaranteed by the flow of votes giving citizens the illusion of being in control of politics, in China, since there is only one party de facto, there are no alternative outlets to the wrath of the people. There is no Beppe Grillo.
The stability of the country and the party are synonymous and the CCP owes its longevity to the social pact with citizens: I govern, you do not deal with politics or criticize and I guarantee you economic well-being and social stability. It has been running for 45 years
In addition to the will, China also has the macroeconomic means to avoid systemic crises: 1) It beats money; 2) Decides the yield curve at the table; 3) It has no deficit limits; 4) Decides the change at the table; 5) Control the current account through independent commercial policies; 6) Check the incoming and outgoing capital account; 7) It doesn’t have an international currency, so it’s not at the mercy of Wall Street. Finally, key to everything, 8) It has no large external debt. They have all the economic levers that are denied to us.
The creditors of Evergrande that Beijing will be interested in are, in order: 1) Individuals who have paid in advance for undelivered apartments; 2) Individuals who have invested in structured products with double-digit returns; 3) Bondholders; 4) Shareholders; 5) Foreign investors.
This is the list of priorities that I sensed to be in the minds of decision makers, with growing haircuts. Almost zero for the former. While it is acceptable for a citizen to buy a house and see its value decrease, especially if it is a second home, it is absolutely unthinkable that those who have paid a deposit will not be given the property, because the real estate channel as a precautionary saving in a company where welfare is weak must be maintained.
This group must therefore be protected. Within this, there is a band where the apartments are close to delivery and these assets are easily redistributed to other real estate companies. The case of those apartments that are now only land is a little more complicated, but it is here that the government will “invite” the players in the sector to participate in the stew, which is in their own interest to keep the sector on its feet and to be “Good citizens”, which is useful today. I insert an intermediate category, that of suppliers (cement, wood, etc.) which must also be protected to allow the continuity of the value chain.
For those who have invested in structured products (WMPs) there will be negotiations that, I guessed between the corridors, will aim for a haircut such that the overall return is zero or slightly negative for the first investors and decreasing for the new ones. For example: you make a haircut of 50% on the nominal, but those who invested four years ago and received four coupons of 10%, in total take 90% of the capital. Those who invested yesterday undergo an initial haircut of 50% and can hope that the initial hypothesis, i.e. strong GDP growth in the coming years, will materialize. As well as in the 90s.
Whatever happens to Evergrande, China has a chance to repeat Draghi’s whatever it takes and avoid systemic risks. Knowing how things go here, it will.