Remember the Evergrande crisis?
It was little more than a year ago that Evergrande Group, the Chinese property developer, was about to collapse under more than $300 billion in debt. There were warnings of a catastrophic default that would ripple through China’s economy, maybe even set off a global depression. China, it was said, faced its “Lehman moment” — when a corporate failure like that which felled the once-venerable Wall Street investment bank in 2008 finally forces Chinese Communist Party policymakers to reckon with systemic financial weakness.
Not quite. Evergrande is not out of the woods, but a catastrophic implosion has been avoided after the Chinese government stepped in to help arrange a restructuring of much of its debt. Well before a new threat to the global financial order emerged this month — the collapse of Silicon Valley Bank in the United States — Evergrande had largely fallen out of the headlines.
Evergrande’s troubles weren’t the first time we’ve heard predictions of Chinese financial doom. They tend to resurface every few years. But Wall Street, the Western media and economists who repeat them make the fundamental mistake of applying pure market logic to China’s economy, and it just doesn’t work that way.
China is still not a fully market economy, despite the country’s 2001 entry into the World Trade Organization, decades of economic reform and a slow but steady integration into the global financial system.
That doesn’t mean China can indefinitely defy economic orthodoxy, and debt levels in its financial system are alarmingly high. But the doom and gloom is usually overblown because the government has virtually unlimited power to head off crises by directing resources — and apportioning pain — as its sees fit, often by ordering banks and other creditors to accept losses for the greater good before things get out of hand.
Evergrande is a prime example. One of China’s largest real estate developers, it amassed huge debts to expand its business, as did many of its rivals. But when China’s government began imposing financial restrictions on property companies in 2020 out of concern over spiralling debt and home prices, Evergrande was cut off from further fund-raising and formally defaulted on its debts in December 2021. The “Lehman” warnings reached a crescendo.
But Chinese officials had already been at work corralling Evergrande executives, creditors and potential asset buyers to begin restructuring the company’s obligations. Domestic lenders eventually agreed to give Evergrande more time to repay loans. A deal to resolve Evergrande’s offshore debt also is reportedly imminent.
In 2008, the U.S. Federal Reserve and Treasury Department also stepped in during the subprime lending crisis to coordinate the restructuring of troubled institutions. But creditor and investor rights and the political risks of bailing out banks limited what American regulators can do; arrangements were reached only after hard bargaining with banks and investment houses. In China, financial institutions have to do what the government tells them.
The government’s hand is everywhere. The most fundamental asset in China — land — is owned or controlled by the state. The value of China’s currency, the renminbi, is government-managed and regulators are widely believed to intervene in trading on the country’s stock markets.
Most of China’s biggest and most powerful companies, including all of its major banks, are state-owned, and executives are usually members of the Communist Party, which controls top-level corporate appointments. Party committees within corporations further ensure that many important business decisions align with government policy. Even healthy and influential private companies can be ordered to undergo painful restructuring or curtail certain business operations, as a government crackdown on e-commerce leader Alibaba and other Chinese tech giants that began in 2020 made clear.
Ultimately, all of this serves the party’s absolute priority of maintaining social stability; there is zero tolerance for financial distress or major corporate failures that could trigger street demonstrations. And government control of the business sector is only increasing.
Even the makeup of China’s high debt levels has a silver lining for regulators. China’s aggregate ratio of debt to gross domestic product was almost 300 percent (or around $52 trillion) in September 2022, compared to 257 percent for the United States. But less than 5 percent of China’s debt is external, amounting to $2.5 trillion, one-tenth of the U.S. level. When nearly every renminbi borrowed is domestic — lent by a Chinese creditor to a Chinese borrower — it gives regulators a degree of control over debt problems that their Western counterparts can only dream of.
China has encountered its share of financial distress during its decades-long transition to a modern industrial economy, but regulators have used their considerable powers to repeatedly prevent catastrophe. When the percentage of nonperforming loans at Chinese state-owned commercial banks hit an alarming 30 percent in 1999 (the U.S. rate, by comparison, has remained in single digits for decades), authorities formed asset management companies to take over those bad loans. During the 2008 financial crisis, China implemented a massive stimulus package to protect its economy.
Still, warnings of a Chinese financial reckoning resurface now and again. In 2014, when a Chinese solar-panel manufacturer defaulted on bonds, some intoned that this could be China’s “Bear Stearns moment”, referring to another U.S. investment bank that collapsed in 2008. But can anyone even remember the name of that Chinese company anymore? (Shanghai Chaori Solar Energy Science and Technology, for the record).
But instead of introducing reforms to establish a healthy market-based economy in which inefficient businesses are allowed to fail, China’s Evergrande-style fixes — while defusing short-term crises — reward irresponsible behavior and perpetuate the excessive borrowing and wasteful use of funding that leads to recurring financial distress.
Soft landings may become harder to achieve. China faces perhaps its greatest array of economic challenges since it began reopening to the outside world in the late 1970s: high debt, an ailing real estate sector, a long-term economic slowdown, rising unemployment, an aging and shrinking population and worsening trade and diplomatic relations with the United States.
There is a very real risk that China could suffer the same fate as Japan, which is still struggling to emerge from an extended period of economic stagnation that began in the 1990s. Japan’s troubles were caused, in part, by a burst real estate bubble and financial-sector problems similar to what China is now facing.
China’s regulatory troubleshooters have proven the financial doomsayers wrong again and again. But their biggest test may yet lie ahead.
Zhiwu Chen is director of the Hong Kong Institute for the Humanities and Social Sciences and a chair professor of finance at the University of Hong Kong. He was a professor of finance at Yale University from 1999 to 2017.