Over the past few weeks, the world has been watching the Chinese real estate market and wondering if the debt problems there will spread to the rest of the economy, or even the rest of the world. In this explainer, the authors try to unpack what could happen next and why the possibility of an Evergrande collapse may not be the catastrophic event some market watchers predict.
The Chinese economy requires deleveraging. That was the rationale behind China’s ‘three red lines’ policy and it is likely Chinese policy makers knew what this policy would mean for over-leveraged companies like Evergrande. However, this was likely a cost China was willing to pay to avoid a ‘lost decade’ situation like Japan post-1989. This makes it likely that Chinese leadership will not bail out Evergrande – all that would do is continue their debt-laden business and create a moral hazard (i.e. other companies would not reconsider their debt-levels with a belief they too would be bailed out). However, what is more likely is that China protects the rest of the financial system by printing money, distributing it to local banks and Evergrande debt holders, and allowing them to retire Evergrande debt without threatening solvency.
Obviously all of this is speculation. However, it is probably useful speculation to temper the most alarmist of financial media. Reports of contagion and ‘China’s Lehman moment’ gets clicks and sells newspapers. However, there are scenarios where Evergrande could fail but the effects of their failure be contained. According to this article, this is the most likely possibility.
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