China's real estate crisis: The fall of Evergrande, economic turmoil, and the quest for a 'prosperous society'

A key decision by Chinese authorities in recent weeks was the official declaration of bankruptcy for Evergrande, a titan in the real estate market. The Hong Kong court announced the judgment, confirming what other players in the Chinese market had feared. "After nearly three years of struggle, bids, inquiries, and speculation, it has become evident that the 'too big to fail' principle does not apply in contemporary China" - highlights Professor Bogdan Góralczyk.

The professor elaborates that the construction industry constitutes one-third of China's GDP, which isn't particularly good news. "Excessive construction has occurred, as numerous new apartment buildings, even entire settlements, were instantaneously dubbed 'bearded' because they were either barely or not occupied at all, leaving wind to whistle through the vacant structures" - explains the author of the analysis.

He also points out the reasons behind China's construction gigantism. Following the 2008 crisis, China allocated $610 billion (4 trillion yuan) towards investments. "Ghost towns sprouted, like the architecturally intriguing Ordos (Kangbashi), a city classified as an urban prefecture in China, in the Inner Mongolia Autonomous Region. The city was fully equipped with infrastructure, yet no one resided there permanently" - we learn from the "Financial Observer".

The investment boom had two facets. "Rapidly expanding development companies, which offered the prospect of earning substantial sums and consequently influencing authority, colluded with local governments under dubious circumstances, resulting in the forced relocation of residents from their homes on lands designated for new investments. This questionable practice has flourished for numerous years, possibly even decades" - notes Prof. Góralczyk.

These investments also amplified societal stratification. "Local officials and individual developers swiftly became wealthy as fortunes increased, while regular citizens, especially the young, had increasingly tougher hurdles to overcome in order to secure a new apartment. Granted, there was a vast supply, but the prices were also grotesquely high," writes the article's author, pointing out that renting an apartment in Beijing or Shanghai is more costly today than in New York.

This escalating social stratification coincided with other setbacks in the Chinese economy. The primary issue is increasing youth unemployment, followed by lingering repercussions from the pandemic.

"Ambitious objectives conceived by Xi Jinping associated with the creation of a 'prosperous society' swiftly encountered obstacles in the near future, specifically 2022. It emerged that the two Chinese COVID-19 vaccines do not target its new variant, necessitating prolonged lockdowns in major cities like Shanghai and Chengdu. These urban closures have imposed significant economic (and social) burdens, with which the authorities continue to grapple - the previously rapid growth rate has evidently decelerated" - we glean from the analysis.

The solution selected by Chinese authorities was ideologically driven, reflecting "an inclination towards egalitarianism, balancing incomes and wages, with conspicuous disdain for pure market forces".

He notes that Xi Jinping personally issued a directive stating that by 2035, China must become a "prosperous society" (gongtong fuyu), edging closer to the income categories of, for instance, Taiwan or South Korea.

In practical terms, this decision implied that fresh responsibilities were imposed on companies, including property developers. These requirements, rooted in political will, were designed "to promote income equality and support marginalized or disadvantaged groups".

It quickly came to the surface that some of these giants, like Evergrande, are fragile entities on shaky foundations. In June 2021, it was announced that the company was heading towards bankruptcy, and by August it became clear that its financial obligations and debt had exceeded $300 billion - discloses the author.

Over the past few years, it became clear that a company managing 1,300 developments across 280 cities simply couldn't collapse without potential social unrest from those who had invested in the company's real estate projects. So why did the Chinese authorities ultimately allow Evergrande to fail?

- The financial burden of lockdowns laid bare the enormity of the bubble that had formed within the local real estate market during prosperous years - the article's author reports.

The author points out that several giants with similar frailties exist. One such company is Country Garden, slightly smaller in scale - with a market cap of 200 billion PLN (~ $50 billion) - and involved in overseas ventures. Facing this company, China might opt for a different strategy - not allowing it to collapse in an effort to protect its reputation.

"In December 2023, the Shenzhen Stock Exchange decided to extend its shareholding for another year, and what lies beyond that period remains uncertain. [...] Although the court's judgment was delivered in Hong Kong, mainland authorities will not permit the effects of the bankruptcy to impact the company's customers. The only outstanding question concerns how and who will assume control and management of the bankrupt estate? No one knows as yet, due to the unprecedented scale of the situation" - writes Prof. Góralczyk.

In 2021 and 2022, Evergrande suffered a combined loss exceeding $81 billion, according to financial data released significantly later than usual. The company's total debt surpassed $300 billion.