How China and Evergrande Are Trying to Avoid Disaster

In a bit, we'll hear from Logan Rights of Rhodium Group and Bloomberg's own David Chu on why the ghost time problem that has long haunted China's economy is coming to a head. To start, though, Bloomberg's own Tom Hancock has gone trick or treating at the Hong Kong headquarters of ever Grandy, one of the developers that built all

that empty property. Let's see what candy he collected. Yeah, I've come to the headquarters of China Evergrand Group in Hong Kong, the epicenter of a burgeoning debt crisis that the sharply slowed growth in the Chinese economy. The sides of the twenty six story building are plastered with advertisements for Evergrands luxury property developments, but it's the headquarters itself which has been up for sale this year. Evergrand tried to raise two billion dollars by selling it off to

pay debt, but the deal hasn't progressed. Evergrand staff who walked the lobby's marble floor and take elevators to their offices face an uncertain future. In a cafe next to the building's lobby, Evergrand staff meet over covees or soft piano music plays. More than a month after entering its acute phase, the financial drama at the company that had been China's largest property developer until recently is far from over.

After waiting about a month for an interest payment, some of Evergrand's dollar bond holders received their money over the weekend, allowing the company to avoid a default for now, but investors have little insight into how long Evergrand can continue to pay its bills. The bonds initially had a bit of a pop and then sort of very quickly came back down to almost unchanged. On the day. That's Monica

saw of Triatic Capital an asset manager UM. I think that UM it made made sense for them to pay this just pretty much about a day before the end of the grace period in order to kick the can down the road while they figure out a comprehensive resolution to this. This whole Osaka, like many in the market south,

sees the hand of China's government behind the scenes. Evergrand status as China's biggest dollar bond issue means whether it pays its bills will help determine how easy it is for other Chinese companies to access overseas lending in the future. So the payment of this coupon, I would assume does involve the government, including the p POC, in order to maintain stability of the whole financial system. I think that much is sort of clear to the market. The heart

of evergrands troubles are its high debt burden. It counts more than three hundred billion dollars in liabilities and a slowdown in sales attributable to the Chinese state itself. According to Juning, a former advisor to China's Central Bank, the Chinese government is trying to reduce the economy's dependence on real estate. He argues that a constant expectation of rising prices among households has created a bubble that threatens financial stability.

Team but in the process of trying to deflate the bubble by slowing housing sales, officials are undermining the finances of huge companies like ever Ground, that in turn creates a threat to financial stability. If you crack down the bubble, you would create a financial brisks on its own. But if you don't, you wouldn't be able to convince the market that you really minute. I think that's the here

in challenge Chinese regulate or Chinese comment phase. Evergrund sales fell by a whopping nine percent during China's October holidays, usually a peak period for home buying, as the government told banks to limit mortgage lending and buyers also worried about ever grounds ability to complete its construction projects. Juning believes that Beijing will continue to try to slow housing sales until households lads their expectations that the government will

always step in to support house prices. I think the end of it is to have the market, have the household to have been fairly study explanation of the housing part, but I don't think we're reaching that point yet, Evergrand needs to focus more on selling off its considerable assets to keep servicing its huge debt pile, since it has less money coming in the door from home bias. The trouble is it's having difficulties finding any bias for those

as well. Evergrand has also tried to sell its property management arm, which charges homeowners fees for organizing services like security and cleaning. It hoped that that would bring in two point six billion dollars, but talks about that also ended without a deal. Evergrand's founder and chairman, Wakayan, has

always been a risk taker. He was born into grinding poverty in the central province of her Nan in the nineties fifties and founded his property company just as China began to create a commercial housing market in the late night nineties. Two decades later, in seventeen, he was China's second richest man. So far, Way has been low key about the details of Everground's finances, avoiding media engagements. However, local press accounts suggest he is sticking with the kind

of big, bold bets that have defined his career. The Securities Times reported that Way plans to scale down real estate operations and won't buy much land for another ten years. The new focus designing and manufacturing electric vehicles. The company got into the new energy vehicle's business a couple of years ago, but as yet to manufacture a single car. Everground faces more tests in the coming weeks as the

grace periods on more bonds expire. The fate of one of the world's largest real estate firms and the world's biggest real estate market still hangs in the balance. For Bloomberg News, I'm Tom Hancock in Hong Kong. Scary stuff forever grandy bond holders and with ever grandy emblematic broader problems in an overbuilt, an over leverage property sector. Scary stuff also for China's economy and financial system as a whole.

To get into those broader issues, I'm joined now by Lugan Right, a director at Radium Group and veteran analyst of China's financial system, and Bloomberg's David Chew, both of them dialing in from Hong Kong. Logan, let me start with you. Why is a downturn in real estate potentially such a big problem for China. I think it's a it's a big problem largely because just of the size of the property sector within China's economy, which most analysts

estimate between twenty of GDP. Overall property sales in China in terms of just the pre construction sales are as high as fifteen point seven trillion u N over the last um year, of the last twelve months. And so if you hypothetically look in the future and if property sales decline by let's say over the next year and prices are down by say ten percent um, that's a huge gap that it's very difficult for developers to make up.

It's a gap as high as three point five percent of g d P. It is not a an imbalance that is easily remedied by policy. So this is one reason that the you know, the potential costs of such a property downturn that exemplified by ever grands difficulties are so significant. And it's not just a growth risk we're talking about here, is it a slump in the property sector could mean defaults on loans and end up in a financial crisis, a Lehman movement for China, if you

will lugan, how could that plan? The more likely scenario that we would be concerned about in terms of financial distress in China stems through local governments and the difficulties of property developers continuing to um slow down their purchases of land, which would add to financial stress among China's local governments which depend heavily upon land sales for revenue

and repaying their own significant debt burdens. So what you could see is if you have a continued slow down in land purchases, you could have a rise in financial distress at smaller banks that lend to these local government financing vehicles, which have really lad the expansion in China's debt over the past decade, which were also essential to

the funding um the investment that has taken place. David Chew, You've worked inside the People's Bank of China, and not just inside the People's Bank of China, but inside the financial stability vision of China's Central Bank, the group which cares most and focuses most on this kind of problems. How do you think China's policymakers are thinking about what's going on with ever Grandy and some of the broader

risks that Logan has described for China's financial sector. The banking sector is the key, particularly the big banks are the key. They are the natural firewall for the financial crisis or financial risks because they have the guarantee from the government. So for example, if you're deposit the money into i CBC, that means you are you are depositing it with with the with the government, so that is

the SEBC. Under the big banks, they are steign credit so that this makes them a natural firewall during a credit crisis or credit risk. Remember what happened thirty years ago in ninety nineties, hialized banks used that to have at pent on the Rachel but the banks was still surviving. And that tells us how confident that people are to the banking sector. So the principle for us is even the banking sector remains good and this do have the

credibility things will be good. So data is the the most ultimate backdop or backstorm for for the all the argument, logan, help me out with one crucial question before we get back to the substance of this ever grand or ever grandy. I've heard both the translations I've been What I hear most often is ever grant, But you know, technically it's a you know, it's und do so it's a question of whatever English and translation prefer, the Chinese will still

operate historic. I went with ever Grand, but ever Grandy seems to have much more of a dramatic flourish to it, So I think I'm going to put the accent on the going forwards fair fair enough, So so Logan and David makes an important point, doesn't he There is a powerful firewall in the financial system in China, which is the credibility of the big banks. And as long as the I C, B c s and the China construction banks of the world a solid it's difficult to imagine

a systemic crisis in China. Do you agree with that point? And what could happen in your view to start eroding confidence not just in a property developer or a local bank, but in the giant state banks which dominate the system. I mean, I think it's very improbable that giant state banks would suddenly lose confidence among the local population. But the concern I would have is in state guarantees being

eroded over time. The issue in China's financial system has been that the system expanded when there was a high degree of moral hazard um that was pervasive throughout a number of different asset markets. So the idea was that even when there was financial stress that occurred, investors didn't need to protect themselves because they could always count on Beijing to step in in the case of any financial stress. We saw this during even the stock market meltdown in

we saw this during the inner bank market turmoil. And so that assumption, that track record of interventions over time created the impression that there would always be um some sort of government support. But that is changing and it

had to change. In fact, it was natural that that guarantee would change because Beijing really had no interest in defending these very risky and peri ferral parts of the financial system when the shadow banking system, when peer to peer lending network started expanding, and as those guarantees have been eroded, it causes investors to start questioning where those Beijing's guarantees will truly extend, where they will stop looking longer term logan, China has to transition away from property

as a driver of growth. You mentioned that contribution of property to GDP that has to come down. That's going to be a painful process, isn't it. I would think. So the issue is just that when an industry is that large, there's no obvious replacement. When something that goes from powering the economy becomes a meaningful drag on the economy.

You can talk about transitioning growth models, but that becomes a longer term process, and it requires the costs of the previous investment to be to be paid and new investment decisions to be made, which which take time to be productive. So it does mean that, you know, whatever you're thinking about China's long term growth trajectory becoming um it probably involves that being a couple of percentage points

lower in the immediate future. David, the last word to you, We've already seen China's economy really screeched to a halt in the third quarter. If you look at the quarter on court at growth rate just no point two, way down from numbers we used to see in the pre COVID era. Do you share Logan's view that working through these deep problems is going to require a period of lower growth. Before answering this question, we should think of one thing. It is why the authorities are so tough.

Could real actate a sector for the past of a couple of years. So I think we can we need to think of it in the bigger picture, and in my mind, I think that the UH, the top leaders, they realized that China needs the transition and they are willing to UH to endure a period of slower growth UH in the next couple of years. That is the price for transition. I think that is what in their minds.

So this can explain what happened in the past several quarters after China recovered from the COVID nineteen that they accelerated the reform and the transition and many of the Titan issue Titan policies issued. I think the view it a time window for the transition and they are willing to pay some price for that. But on the other hand, I think they won't allow the growth to to to break the bottom line. I think one of the bottom

line is the employment. So if we see the rise of the unemployment, we will see some policies to be made to relate to the the economy. Well, if we have to sum up such a complex discussion, I guess we can say that, Ever, Grandy is probably not going to be China's Lehman moment. A financial crisis is not an immediate prospect, but a period of lower growth as the economy works through the problems of overbuilding and over capacity is a very real prospect. David, you logan, right,

thanks very much, thank you. Well, It's Halloween this Sunday, and so in the spirit of the season, we've invited Bloomberg Economics best vampire hunters and monster slayers to tell us about the biggest risks, the scariest risks facing the global economy and markets. Very pleased to be joy by chief US economist and a Wall dialing in from Washington, d C. Senior UK economist Dan Hansen joining us from London, and Chief Emerging Markets economist z Dowd dialing in from Dubai. Zad.

Let's start with you tell us about the beastly problem facing the emerging markets. So we know do things from history. We know the first thing is that rising US rates have a negative spill over to emerging markets, and the second thing is that weaker economies in the developing world gets hit harder. We saw that repeatedly in recent years, including the two thousand and thirteen Taper tantrum. We saw

it also in the twenty eighteen emergent market crisis. Now US rates are rising, and some emerging markets are vulnerable this time around. So who is the most exposed was the group of countries that we group under the acronym BEAST.

These are Brazil, Egypt, Argentina, South Africa and Turkey. These economies have law foreign exchange reserves, have high external debt and sizeable current account deficits, and the particularly exposed if you get any surprises in terms of interest rates in the US now, fans of the horror genre will know that often the sequel is gorrier than the original. In the UK, we had strikes, shortages, garbage, even corpses piling

up in the street. The crisis was so bad it became known as the Winter of Discontent, Dan Hansen, does the UK now face winter of discontent? The return? We've had a year of two halves in the UK. We've had a blistering recovery following the end of the lockdown earlier in the year, but since then the economy has slowed and much of that has been due to, as you mentioned, supply constraints both global and domestic as well, and they've really hindered the ability of the economy to

make meaningful further progress. And we've had a look at what recent supply disruptions might cost the economy, and we think it could knock as much as one point three percent off the level of g d P by the end of the year, and it could add as much as point four percentage point to headline inflation, which as

we know, is already pretty high in the UK. It's running at about three point one percent at the moment, and I think if we look ahead, it's important to recognize that that loss of growth momentum has occurred at a time when more headwinds are appearing on the horizon. Inflation is likely to go higher still on energy prices this winter, moving above four percent, more than doubling the Bank of England's target, and that will crimp real income growth.

And meanwhile you've got fiscal support being tapered, and there's also a risk of a rising unemployment following the end of the furlough scheme, which the government's wage support scheme. So if we bring all of that together, it's it's not hard to see why references to stagflation are on the rise um, though we don't think we're quite there yet.

Our baseline view is that the economy will continue to grow, albeit at a significantly lower pace than in earlier in the year, And our baseline also sees GDP passing its pre virus peak in the first quarter of next year, which is a little bit later than we previously envisaged. Sometimes in horror films, the problem gets so bad that the heroes have to adopt a scorched Earth policy to wiping out the villains. Remember Ripley in Aliens promising to

take off and nuke the entire site from orbit. It's the only way to be sure, Anna Wong, was inflation in the United States reached that proportion, should we be worried that the Federal Reserve will have to lift off and nuke the economy from orbit to bring price pressure under control. So dud, everybody is worried about inflation here,

even my my, my nanny is worried about inflation. And the risks of inflation moving higher than the FED prediction right now seems higher than a couple of weeks ago, indeed. But to me, the scarier scenario is not so much inflation running away to the level we have seen in nineteen seventies, because for that to happen, the FED has to make policy errors for many, many years, and I just don't think that's likely. The Fed will move, will raise rates next year if inflation runs hotter than much

hotter than they expected. But the real scary thing is what happens to the economy when the Fed does move under the new policy framework. The FET is only going to move until the labor market is really hot, right, So when they do finally start to move, they have to move faster and quicker, and the path of FED rates will be steeper. And we have had two years of very easy conditions monetary conditions. We have many bubbles now,

we have asset record highs in many asset markets. So when the FED brings this party to a halt, it will be very hard. And historically the FED does not have a very good track or record in engineering soft lending. Okay, let's round this section out by talking about perhaps the biggest fear out there for some investors, the fear that record highs for the stock market are the sign of a bubble and that that bubble could burst Z. How

should we think about that risk? Right? So, the main question is whether the stock market is in a bubble or not right now, with the SMP hitting record highs. So to answer this question, we use an econometric model that estimates the large notable bubble based on the speed of decoupling of equity prices from their fundamentals, in this case is dividends. The method finds that we are on the cusp of a bubble. We're not in a bubble

territory yet, but we are very close now. Economically speaking, the direct effect of a sharp correction in the stock market on the US economy my not be very large, but at a time where we have other risks such as the spreading of the coronavirus variant, the rise of global interest rates, the slow down the Chinese economy, and the disruption and the supply chains. Adding a another risk in the form of an assetprise bubble would compand these risks and add an additional layer of uncertainty to the

global economy. Well, Anna, Dan and Zad didn't enter into the Halloween spirit quite as fully as I did, But then I guess on a show like this, it's really economic expertise that counts, and that's about all we have

time for on this week's Stephonomics. So it's the door of the crypt Creaks closed, it only remains for me to thank our contributors, Tom Warlock, Logan White and Demon Chew as Yeah Dead, The Ghost of Anime, Wong and Dan Hank, Song producer Magnus the Thing Henrickson, and executive producer Mike the Exorcist Sasso join us next week, when regular host Stephanie Flanders will be back, The guest host Nightmare will be over, and normal standards of economic analysis

and editorial judgment will be restored