The debt crisis at Country Garden, China’s biggest property developer and once considered a financially sound company earlier this year, has raised fears of a new infection just two years after China Evergrande Group defaulted.

What could happen next?

Since the sector’s debt crisis emerged in mid-2021, companies accounting for 40% of Chinese home sales have defaulted, most of them private property developers.

This has given rise to many unfinished houses, unpaid suppliers and creditors, not only financial institutions, but also ordinary people who have bought wealth management products involving trust financing.

Many offshore bonds now trade at low double or single-digit cents on the dollar, and their share prices have plummeted 90%. There is very little liquidity left in both equity and debt markets as investors and lenders avoid the sector.

With home sales already very weak, the credit crunch could delay the prospect of a recovery for both the property market and the wider Chinese economy, of which real estate is a main pillar.

S&P Global Ratings said Wednesday it could adjust its forecast for asset sales from an “L” shaped recovery to a “descending ladder” figure if Country Gardens officially defaults.

Home-buyers may become even more wary of private developer brands, and house prices in many areas could come under more pressure if Country Garden resorts to fire sales to raise cash.

Local government could further tighten escrow accounts, where pre-sale funds are kept to ensure homes can be completed and delivered – a top priority set by Beijing.

This would result in further pressure on the sector and additional defaults among state-backed developers as well.

How is this time different?

Country Garden getting into financial trouble didn’t hit the market as much as Evergrande did because most private developers had already defaulted. However, this came at a time when the property market and the economy are in a very bad shape.

While Country Garden’s total liabilities of 1.4 trillion yuan ($191.7 billion) are only 59% larger than Evergrande, the world’s most indebted developer, it has 3,121 projects across all provinces of China, compared to Evergrande’s roughly 800.

Evergrande was already bankrupt at the time of the default, but Country Garden still had more assets than liabilities.

Analysts have warned that Country Garden could go bankrupt if it had to write off large reserves, and could go into negative equity if its asset values ​​declined over time.

Is there a systemic risk?

This week, news of missed payments on investment products by major trust firm Zhongrong International Trust Company highlighted massive investments in the property sector of China’s $3 trillion shadow banking sector.

Rising defaults by developers have pushed the non-performing loan ratio of Chinese banks to 4.4% in 2020 from 1.9% at the end of last year, Moody’s said.

But market experts generally do not think China is on the verge of a “Lehman moment,” where the failure of a single company would translate into a wider financial collapse, as financial institutions’ risk appetite in the real estate sector has waned over the past few years. .

China’s property sector accounts for more than half of global new home sales and home construction, and is the world’s largest asset class, with an estimated market value of around $62 trillion.

The next thing to watch is how regional governments, many of which depend on real estate revenue, manage their debt.

The total debt owed to local-government financing vehicles (LGFVs) is estimated by the International Monetary Fund at 66 trillion yuan.

Will the central government intervene?

The Politburo, the top decision-making body of China’s ruling Communist Party, fueled speculation in late July with a statement saying “houses are for living, not speculation” when it removed the oft-repeated phrase . In which it pledged to adjust property policies in a time-bound manner.

But no bold stimulus measures have yet been announced, and industry experts are divided on whether they will be implemented.

Many analysts expect Beijing, which has so far avoided state-funded bailouts, to take drastic measures in the coming weeks to contain the fall.

However, some analysts question the tools Beijing can use to strike a balance between providing support to the housing market and keeping debt under control.

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