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Will China ever be the First Economy?

Updated: Dec 4, 2023

Evergrande is the world's most indebted property developer and has been at the center of an unprecedented liquidity crisis in China's property sector, which accounts for roughly a quarter of the world's second-largest economy. Once the leading property developer in China, Evergrande's financial crisis became widely known in 2021. Since then, both Evergrande and several of its peers have failed to meet their offshore debt obligations. This happened as a result of declining home sales and limited opportunities for raising funds, leading to concerns about a broader economic impact that could affect Chinese banks.

First, let’s understand the framework that led to Evergrande default.

For decades, China’s economy has been relying on a booming real estate sector fueled by population growth. The housing market created jobs and served as a place to store wealth for China’s growing middle class. Local governments also depended on revenue from land sales. In this scenario Hui Ka Yan founded Evergrande, initially called the Hengda Group, a property developer company in the southern city of Guangzhou in 1996, during a period of mass urbanization in China.

Evergrande's business model was to raise loans to buy land, sell homes on the site before they were built and use the cash to pay lenders and finance the next real estate project. For two decades, starting in the mid-1990s, this approach was enormously lucrative as Chinese home prices soared. It transformed Hui, a former steel industry employee from a rural village, into China’s richest man and it turned his company into a vast real-estate empire. The group's real estate unit currently has more than 1,300 projects in more than 280 cities in the country, according to its website. In 2009, the Chinese developer raised US$722 million in the initial public offering on the Stock Exchange of Hong Kong.

That growth was then amplified by Mr Hui's "maximum leverage" approach, according to Jackson Chan from financial markets research platform Bondsupermart. Mr Hui's business empire grew to encompass far more than just property, including wealth management, electric car making and food and drink manufacturing. It also has a majority stake in what was once China's top football team, Guangzhou FC.

But Chinese officials grew concerned that property developers were becoming so big and had borrowed so excessively that if they toppled, all that debt might drag down the country’s financial system. In 2020, the central government restricted the ability of real estate companies to borrow from banks. The policy, known as the “three red lines,” put a limit on how much debt developers could have and left companies like Evergrande desperately seeking for cash and turning to more risky ways to avoid a liquidity crunch.

It’s fundamental to highlight that the country's population isn’t growing the way it used to, and years of strict Covid-19 restrictions shook Chinese consumers. Home prices have slumped, denting Chinese households’ savings and confidence, as the government tries to transition from an economy powered by state-directed investments and exports to one led by domestic consumer spending.

Evergrande default and debt reconstruction plan

Signals of crises became evident in August 2021, when many Evergrande projects across the country halted construction due to overdue payments. China's central bank and banking watchdog summoned senior executives and issued a rare warning that the company had to reduce its debt risks and prioritize stability.

Then in September 2021, it missed two offshore bond coupon payments totaling $131 million. Evergrande engaged financial advisers to examine options, warning of cross-default risks amid plunging property sales. Two months later, Hui Ka Yan (Evergrande chairman) sold 1.2 billion shares worth HK$2.68 billion ($342.7 million), lowering his stake in the company to 67.9% from 77%.

With $300 billion in total liabilities, Fitch Ratings declared the property developer to be in default on its debt; two interest payments that were due on Dec. 6, 2021, when a grace period expired, were not made. More specifically, Fitch downgraded its rating of Evergrande to "restricted default," which means that the Hong Kong-based property development company had neither ceased operations nor commenced formal legal procedures such as filing for bankruptcy.

In March 2022 the situation deteriorated even further, when Evergrande suspended trading in its shares, citing its inability to publish audited results before March 31. In addition, there was an investigation of the property management arm in which 13.4 billion yuan of deposits were seized by banks and then a mansion belonging to Evergrande's chairman in Hong Kong's prestigious -The Peak residential enclave- was seized by lender China Construction Bank (Asia).

In December 2022, the property developer said it had resumed work on 631 pre-sold and undelivered projects. However, in the following months it revealed its then auditor resigned amid disagreements over matters relating to the audit of its 2021 accounts and an independent committee found Evergrande's directors fell "below standards" through their involvement in diverting loans secured by unit Evergrande Property Services (6666.HK) to the group.

In March 2023, these factors culminated in Evergrande's decision to announce plans for the restructuring of its offshore debt, giving creditors a basket of options to swap their debt into: bonds and equity-linked instruments backed by the group and its two Hong Kong-listed companies, Evergrande Property Services Group (6666.HK) and Evergrande New Energy Vehicle Group (0708.HK).

Between April and July 2023, it stated 77% of the holders of class-A debts and 30% of the holders of class-C debts had submitted their support for the restructuring proposal. Still, it is necessary to highlight the net loss posted by Evergrande, of 476 billion yuan and 105.9 billion yuan for 2021 and 2022, respectively, versus a net profit of 8.1 billion yuan in 2020 when its operation was normal.

In August 2023, the group said it was planning to seek protection under Chapter 15 of the U.S. bankruptcy code, which shields non-U.S. companies that are undergoing restructurings from creditors that hope to sue them or tie up assets in the U.S. It reported a 33 billion yuan loss in January-June, versus a 66.4 billion yuan loss in the same period last year. Trading in Evergrande's shares resumed after 17 months, with 79% of its market value lost from when it was last traded. China's National Administration of Financial Regulation approved the setup of a state-owned insurer to take over all of the assets and liabilities of Evergrande Life Insurance, a 50%-owned investee company of Evergrande.

But Evergrande’s efforts to get a handle on its debt are now (September) being complicated by another major problem the company is facing: current and former officials are targets of criminal investigations. The police in southern China said public security officials had detained staff at Evergrande’s wealth management arm and imposed “criminal compulsory measures.” The Chinese news media also reported that the authorities had detained the company’s former chief executive, former chief financial officer and former chairman of its life insurance unit. While Evergrande has not said much about the investigations involving these former executives, it confirmed the inquiry into Mr. Hui but it did not mention what crimes were being investigated.

Evergrande also said it was unable to issue new debt - a crucial step in a restructuring - due to an ongoing investigation of its main unit. Bondholders of the embattled property developer said a few weeks ago they were surprised by announcements that its restructuring plan failed to meet regulatory requirements, and raised concerns about a possible liquidation.

Lastly, Hong Kong court gave China Evergrande Group a five week reprieve to come up with a deal with creditors or face liquidation after the embattled developer said on Monday it was working on a revised debt restructuring plan.

The Chinese real estate crash has begun

Over the past decade, China has been the source of more than 40 percent of global economic growth, compared with 22 percent from the United States and 9 percent from the eurozone, according to BCA Research.

A decline in consumer spending in China hurts companies that do business there, like American technology firms and European luxury goods groups. A weaker Chinese economy also means less appetite for oil, minerals and other building blocks of industry. China is one of the United States’ largest trading partners, purchasing billions of dollars of American crops and machinery each year.

By one estimate from Gavekal Research, unpaid bills from private Chinese developers total $390 billion, a major threat looming over the economy. Economists have downgraded their forecasts for China’s economic growth, many to below the government’s target of about 5 percent. Both imports and exports have fallen in recent months, and foreign investment into the country dropped more than 80 percent in the second quarter from a year earlier. Consumer prices in China fell in July for the first time in two years, a sign that Chinese households were spending less.

China’s debt-to-GDP ratio rose to a record in the second quarter, although consumers and businesses are borrowing at a slow pace, reflecting low confidence that’s hitting economic growth.

For decades, the property boom fueled spending by China’s growing middle class, who kept a great portion of their wealth in real estate and felt confident when their homes increased in value. Now, the “negative wealth effect” of falling home prices has curbed their desire to spend, and people are hoarding cash.

A potential liquidation of Evergrande could hit households and confidence in the battered real estate market, setting back Beijing’s efforts to revive the sector and prevent bigger economic problems.

More than 50 real estate developers in China have failed to make payments in the past three years, according to Standard & Poor’s. The government recently outlined programs aimed at spurring spending and investment, but the details have been opaque.

Households are already highly leveraged for housing and have little room to borrow for consumption, ” said analysts from Stanford University and the Asia Society Policy Institute (ASPI) in a recent report. The priority should be for the government to rapidly create alternative venues of income growth aside from housing that will encourage households to consume.

Demographics help explain the desire of many Chinese to save heavily. “The social security system is still developing slowly, with the main pillar of China’s pensions stuck in deficit since 2014,” Oxford Economics analysts said. Without an adequate pension system, precautionary savings have been “high and sticky,” at around 32% of personal disposable income, they pointed out.

Chinese authorities need to find ways to boost disposable incomes and improve productivity.

Is China losing traction to the increasing power of India?

China's economy has slipped into deflation as consumer prices declined in July for the first time since February 2021, with its significant economic slowdown due to prolonged COVID-19 lockdowns. In September, China's consumer prices remained flat, while factory gate prices saw a third consecutive month of annual declines. This suggests an uneven post-COVID recovery in the world's second-largest economy, possibly requiring additional policy support. The producer price index fell 2.5% from a year earlier, weaker than expected, but the smallest drop in seven months. This deflation in China could impact the world in two ways. On the positive side, it may help curb rising prices in other parts of the world, India. On the negative side, it could impact employment, business investments, and consumer spending in China, leading to a vicious cycle of economic inactivity. Especially, China's role as a substantial importer of iron ore from India, constituting almost 70% of its imports, means that any economic deceleration in China could lead to a reduction in imports, potentially affecting India's economic situation.

However, nothing talks better than numbers in these situations, therefore we decided to take a look at the most important indexes to assess economic growth of countries. Starting off, the sharp rise in foreign direct investment inflows into India over the last decade reflects the favorable long-term growth prospects of the Indian economy, driven by a youthful demographic structure and rapidly increasing urban household incomes. Projections suggest that India's nominal GDP will be doubling from USD 3.5 trillion in 2022 to USD 7.3 trillion by 2030. This rapid pace of economic expansion is set to elevate India's GDP above that of Japan by 2030, positioning it as the second-largest economy in the Asia-Pacific region. In 2022, India's GDP had already eclipsed that of the UK and France, and by 2030, it is anticipated to surpass Germany's. The Indian economy's promising future is driven by several growth drivers. A growing middle class propels consumer spending, making India an attractive investment hub across manufacturing, infrastructure, and services. The ongoing digital transformation is poised to revolutionize the retail sector, attracting global tech and e-commerce leaders to India.

Indeed, in its pursuit of diversifying its manufacturing beyond China, Foxconn, a key Apple supplier, has commenced the production of the iPhone 15 in India. This development was reported by Bloomberg in August. Following a meeting with Indian Prime Minister Narendra Modi at the White House earlier this year, Apple CEO Tim Cook expressed his optimism about India being a 'significant opportunity. ‘The decision to produce the latest iPhone in both India and China primarily stems from supply chain challenges experienced by Apple in China. Notably, one of Apple's vital Chinese factories had to temporarily close due to a Covid-19 outbreak, triggering subsequent protests and a shortage of iPhones during the 2022 holiday season. This supply disruption led to extended waiting periods for customers. While the primary motive for diversification is economic, some experts suggest that increasing diplomatic tensions between the U.S. and China may have also played a role in Apple's decision to expand its manufacturing beyond China, although this is not the primary factor. Moreover, Apple is not alone in relocating production from China, with Microsoft shifting some Xbox manufacturing to India and Amazon commencing production of Fire TV devices in Vietnam.

FDI Analysis

According to the World Bank, “Foreign direct investment are the net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor. It is the sum of equity capital, reinvestment of earnings, other long-term capital, and short-term capital as shown in the balance of payments”. Statistical data indicates a noteworthy trend wherein the FDI inward position, as a proportion of GDP, has demonstrated a consistent decline in the case of China, while concurrently exhibiting an ascending trajectory for India. The factors that cause these shifts are many, for example India’s large population and expanding middle class offer a significant market for foreign investors. As the Indian consumer base continues to grow and urbanize, it becomes an attractive destination for businesses looking to expand, moreover economic reforms have been implemented to improve its business environment and attract foreign investment. Initiatives like "Make in India" and changes in regulations have made it easier for foreign companies to invest in India. These reforms have contributed to the increasing trend in FDI.


American Depositary Receipts (ADRs) are financial instruments used by investors in the United States to trade and invest in foreign companies' shares. They represent shares of foreign companies, are traded on U.S. stock exchanges, and provide U.S. investors with exposure to global markets. Analysing the graph of data of S&P India ADR Index (USD) NTR (in blue) and S&P China ADR Index (USD) NTR (in brown) provided by the Financial Times it is noticeable how strong the difference is. The strong performance of the S&P India ADR Index indicates that Indian companies listed as ADRs in the U.S. are currently attracting greater investor interest and potentially outperforming their Chinese counterparts.

The correlation between American Depositary Receipts (ADRs) and currency exchange rates is defined by the impact of currency movements on the value of ADR investments. ADRs, representing shares of foreign companies but traded in U.S. dollars, inherently carry currency exposure. The direction of the correlation can be direct or inverse: when the foreign currency strengthens against the U.S. dollar, ADR values tend to increase, as the foreign company's earnings, when converted to U.S. dollars, become more valuable; conversely, a weaker foreign currency can reduce ADR values.

In conclusion, the economic landscape of China is undergoing significant changes, marked by deflation, supply chain challenges, and diplomatic tensions that have prompted multinational companies like Apple to diversify their manufacturing beyond China. This shift, while primarily driven by economic considerations, carries geopolitical implications. On the other hand, India is emerging as a promising destination for foreign direct investment (FDI), with a robust growth outlook fueled by a burgeoning middle class, digital transformation, and a favorable demographic structure.


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