The Taiwan Banker

The Evergrande incident has triggered a chain of financial difficulties among real estate developers. Hank Huang, President of the Taiwan Academy of Banking and Finance, believes that the financial risks due to Evergrande’s default can be discussed from three perspectives: impact on the real estate industry, finance industry, and on the next stage of China's economic development. Deleveraging has been ineffective First, he spoke about the impact on the real estate industry. This crisis has exposed the limitations of the Chinese real estate industry, which relies heavily on leverage to create revenue growth. A high concentration of credit in one industry is an inherent threat to economic stability. The Chinese government is well aware of this and has already carried out relevant and necessary adjustments. In particular, since Xi Jinping came to power, the government has repeatedly attempted deleveraging, especially in the real estate industry. It has never been successful. What we see in the market is that even as leaders have stated that “houses are for living in, not speculation” and imposed the three red lines of credit, market prices continued to rise. Beijing will still need to increase the strength of its crackdowns in order to curb soaring real estate prices. Therefore, the debt crises of Evergrande and other private developers clarify the government’s determination to rectify the situation. Countermeasures by state-owned enterprises would indicate that the Chinese government has finally subdued the real estate behemoth. If, on the other hand, after the commotion, the private sector forms a new relationship with real estate, it will mean that Beijing has once again waved a white flag. Will private industry also retreat from finance? The second item to watch is the impact of Evergrande on China's financial industry, especially on the private sector. Highly-leveraged real estate developers have been making good use of the regulatory features of China’s financial market to raise commercial paper, wealth management products (WMPs), perpetual bonds and other off-balance sheet liabilities, in addition to general borrowing. Huang said that if the Chinese government chooses to let Evergrande undergo bankruptcy and reorganization like HNA Group, “the final result is likely to be a link between further state advances into the real estate industry and the financial industry, allowing government capital to play a more important role in China’s future economic development, and suppressing the role of private capital.” One-way risk will limit growth The final consideration is the impact on the next stage of China’s economic development. Comparing the rapid growth of Taiwan, Japan and China, the common point is that in the rapid accumulation of private wealth, the prices of real assets and other real assets also rose. Huang explained that those countries have all undergone bubble economy stages, which refers to a great amount of wealth chasing limited real assets, which it is bound to eventually require correction and adjustment. In the past few years, as housing prices and real estate development have become important engines for China's economic development, even local governments have relied heavily on land finance – the use of land sales revenue to meet fiscal needs. Therefore, China is more active in controlling housing prices than other countries. Special compulsory transaction price policies in recent years have also played an important role in the real estate industry. Precisely because these interventions have been quite direct and effective in the past, they have maintained the stability of the financial market and shaped people's belief that housing prices only rise, and don’t fall. However, the Evergrande incident has already caused a significant increase in local governments’ bid-for-sale land bids, and a substantial correction of house prices in the short term. The decline has even reached the point where governments have restricted purchase and sale of second-hand houses, as well as price-limit orders, etc., in order to avoid a full-scale collapse. Will these developments shake people's faith in real estate, so that it is no longer the most important tool for wealth accumulation? Or perhaps this will a short-term impact, and the skies will soon clear. Both paths are possible. Taiwan's financial industry should watch the situation closely. Huang however also pointed out that China already has a large oversupply of housing. If empty cities developed with high leverage continue to shrink in value, this will affect the stability of the whole financial system. In this case, reduced private consumption power, already under pressure, will greatly hinder China's economic development goals. After all, in order to create sustained economic growth, it is necessary to effectively direct capital to real production, creating jobs while also earning returns. If savers regard real estate as their main object for investment, and society expects and encourages capital gains from sharp price increases, liquidity problems caused by interest expenses on too many assets will become a problem not only for the real estate sector, but also for the whole economy.