How the Evergrande debt crisis could force China’s hand on reforming government
- An Evergrande collapse would be unlikely to bring down China’s financial system, but unresolved problems could still threaten social stability
- Bloated government, dependence on land sales revenue, shadow banking and inefficient urbanisation are among the issues in need of urgent reform
In 2008, Wall Street banks formed a suicide pact with complex derivatives linking them together. China’s debt issues have laid a trap for a wide section of society, even the powerful mandarins in Beijing. Could Evergrande be China’s “Lehman moment”?
As such, an Evergrande collapse would be unlikely to bring down China’s financial system. However, a host of other problems – such as protesting investors and prepaying homebuyers – could still threaten social stability. Dumping risks on unsuspecting households carries its own version of financial chaos.
To some extent, relying on an unwieldy shadow banking system to cushion the banks has made things worse. Risk management in the shadow banking system is much worse, exacerbating the overall risk level.
Capping leverage will lead to reduced liquidity in the land market. The land price would then fall in the coming months or years and more developers will find themselves in negative equity.
In China’s case, the banking system might need to swallow assets from the shadow banking system for the sake of stability. The clever idea of dumping risk into the shadow banking system was just self-deception.
Resulting measures to raise revenue would put more pressure on households and dampen consumption. Thus, exports would become more important.
A prolonged collapse in demand would force real changes in China. The top issue is the size of the government, which is already too big and getting bigger. Government consumption is more than 15 per cent of national GDP.
Most investment, other than the property sector, is from the government or state-owned enterprises. The odds are that the government will boost its investment to support the economy as the property sector cools.
China needs to concentrate on developing megacities, but the political winds are going the other way. Just when the government will follow the efficiency route rather than its own instincts is anyone’s guess.
China is not like Japan three decades ago. It can still improve its external competitiveness. If it wants to become like South Korea after 1997 and restructure to raise efficiency and income, it needs fundamental reform in the government sector.
The only scenario that forces China to change is a prolonged collapse of demand. The survival instinct will make the government change despite the pain.
Andy Xie is an independent economist