CEO DailyCFO DailyBroadsheetData SheetTerm Sheet

Evergrande is more a symptom of China’s flawed economy than a ‘Lehman’-like threat

September 23, 2021, 11:45 AM UTC

This is the web version of Eastworld, Fortune’s newsletter focused on business and technology in Asia. Subscribe here to get future editions in your inbox.

Eamon Barrett here, filling in for Clay today.

Fearful investors, who have been watching Evergrande slowly crumble this past week, received some respite Wednesday when the highly leveraged property developer announced it had reached an agreement to pay interest due on one of its smaller, renminbi-denominated bonds. But the real estate giant is still on the hook for interest payments on a larger offshore bond due today.

China’s central bank, the People’s Bank of China (PBOC), soothed investor sentiment further yesterday by injecting $18.6 billion of capital into credit markets, signaling the government is insulating China’s economy from the shockwaves of Evergrande’s possible collapse.

But while investors wait to see whether and how Beijing resolves Evergrande’s implosion, the narrative regarding the insolvent company has shifted. Analysts have started discussing Evergrande not as a Lehman Brothers-esque threat to China’s economy, but as a symptom of an economy already in trouble.

“In many ways you don’t have to worry that it’s a Lehman-type situation but in many others, it’s far worse because it’s symptomatic of the whole economic model and the debt that’s behind the economic model,” fabled short seller Jim Chanos told the Financial Times on Wednesday.

For decades, debt helped fuel China’s double-digit economic growth. China has used credit to spur infrastructure spending, prop-up bulbous state-owned enterprises and—in the case of Evergrande and myriad other builders—finance real estate development.

China’s total debt stood at 264% of GDP as of the second quarter this year, with non-financial corporate debt occupying the largest base, and, according to Reuters, debt within the real estate sector multiplying the most among all industries in the five years from 2012.

Beijing knows this debt-driven model of growth isn’t sustainable and for a number of years has talked of accepting a “new normal” of slower GDP growth, where annual rates hover around 5% and the economy relies on consumption rather than debt and industry.

Regulators have issued a slew of policy measures designed to deleverage the banking sector in recent years too and, more recently, have tackled mounting debt in the real estate sector. The government introduced the three “red lines” for real estate funding last August, which cut off loans for over-leveraged developers and channeled Evergrande towards its looming defaults.

That crackdown on real estate funding was necessary. Much like China’s other leaders of debt-fueled expansion, property developers have used loans to build more homes than China really needs. Property consumption is flagging. Home sales dropped 18.7% in August this year from the same month last year. Developers know the property market is entering its end game too and many, including Evergrande, have spent billions attempting to diversify their business interests. Not all have been successful.

The issue underlying Evergrande’s collapse is that, while Beijing is right to rein in debt, weaning the economy off of it will inevitably cause defaults and disruption, and Beijing is unsure how to navigate that mess.

Local governments have grown dependent on land sales for over half of their income. With fewer property sales, taxes will have to increase. Meanwhile, consumers value property as a relatively stable investment asset. The crackdown on real estate developers and property as speculation could cut the return on investment for existing home owners by lowering house prices, and increase household debt by raising rates on mortgages—all while Beijing looks to consumption as the future fuel of China’s economic growth.

Beijing probably won’t save Evergrande wholesale, though it is likely to prevent its collapse from causing contagion. But the issue at stake is how many more times Beijing can avert disaster as it reshapes the fundamentals of China’s economy.

More Eastworld news below.

Eamon Barrett
eamon.barrett@fortune.com
@eamonbarrett49

This edition of Eastworld was curated and produced by Nicholas Gordon. Reach him at nicholas.gordon@fortune.com.

Eastworld news

Security warning

Lithuania’s National Cyber Security Center (NCSC) warned against using Chinese smartphones, particularly Xiaomi and Huawei products. The NCSC said that Xiaomi’s pre-installed system apps, such as its web browser, censors terms considered sensitive in China, such as ‘free Tibet.’ Xiaomi denies the allegation. Relations between China and Lithuania have frayed recently as Vilnius deepens ties with Taiwan. BBC

Overseas coal

President Xi Jinping vowed during a U.N. meeting Tuesday that China would stop supporting overseas coal projects, effectively wiping out the primary source of funding for coal plants across developing economies. However, Xi did not share when this would occur, nor what would happen to coal plants already in development. China’s pledge follows similar statements by Japan and South Korea earlier this year. The Guardian

Gaining control

Ant Group’s lending service Huabei is now part of the credit system under the People’s Bank of China. Chinese regulators had ordered Ant to spin off its consumer lending from its core app. Huabei’s “buy now, pay later” service will now channel account information—including registration dates, credit limits and repayment records—to the PBOC. KrAsia

Not Zoom-ing along

The U.S. Department of Justice is concerned about Zoom’s planned takeover of Five9, which manages call centers and communication networks. The reason is Zoom’s presence in China, which has sparked national security concerns about information being routed through Chinese servers. Zoom denies that calls outside of China are routed through the country. The DOJ review would be a second level of scrutiny on the Five9 deal, which is already being reviewed by the Federal Communications Commission. Financial Times

India left out?

The announcement of the AUKUS security arrangement between the U.S., the U.K. and Australia may have unintended consequences on India’s relationship with Washington. India’s requests for nuclear propulsion were repeatedly rebuffed by the U.S, which said legislation prevented them from sharing technology, even with allies: an argument now undercut by the U.S. deal to sell nuclear submarines to Australia. SCMP

Dueling applications

Taiwan has expressed an interest in joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, or CPTPP, just days after China submitted its application. Balancing the two applications will be difficult, as Beijing increases its criticism of countries trying to deal more openly with Taiwan. Beijing’s application faces hurdles throughout the region, as CPTPP-member governments express skepticism that China can meet the trade agreement’s high standards. Reuters

Markets and movers

Chinese Estates One of Evergrande’s strongest supporters revealed that it has sold part of its stake in the troubled developer, and may end up selling the whole thing. Chinese Estates has been a long-time backer of Evergrande founder Hui Ka Yan, so the move is a sign of diminished investor confidence in the world’s most-indebted developer

Impossible Foods The fake-meat producer has announced plans to launch its pork substitute in Hong Kong and Singapore, as it continues efforts to break into Asian consumer markets. The company will compete with local offerings, like Omnipork, in the fast-growing meat-substitute market. 

Zee Entertainment Sony Pictures Networks India is proposing to take control of India’s largest listed media company. Zee is currently amidst an effort by shareholders, led by Invesco, to oust chief executive Punit Goenka. If the deal succeeds, the combined company would control a third of India’s Hindi entertainment market. 

Korea exports South Korean trade data suggests that exports will slow in September, in part due to repercussions from the global outbreak of the Delta variant. Exports only grew by 23%, compared to 41% in August. Korean trade data is often used as a leading indicator of global economic activity, due to its integration in global supply chains. 

Clover Data from late-stage trials of Sichuan Clover Pharmaceuticals’ COVID vaccine suggests that it prevents 79% of Delta cases, making it one of the first Chinese-developed vaccines to release efficacy data against the more transmissible COVID variant. Other Chinese vaccines, like Sinovac and Sinopharm, have shown a reduced ability to prevent infection from the Delta variant, even as they still protect against death and serious illness.

Final figure

80%

As part of its pledge to open its border by Christmas, Australia is targeting an 80% full vaccination rate. The country has some of the world’s strictest border control policies, with mandatory inbound quarantine and, at times, measures that have barred even Australian citizens from entering. Yet the country still has a long way to go before it hits its target: currently, only 38% of Australians have received two doses of a COVID vaccine.

Subscribe to Fortune Daily to get essential business stories straight to your inbox each morning.