Questions on China

Evergrande liquidation would be keenly watched

On Monday, a judge in Hong Kong, which is officially part of China but has an independent legal system based on British principles, ruled that the liquidation process should begin for property major Evergrande Group. The developer was once the favoured child of mainland China’s property boom, but it has as swiftly become emblematic of the real estate bust, which has cast a shadow over the country’s economic prospects. Once worth hundreds of billions of dollars, Evergrande has now lost almost all its value because it is encumbered with scores of half-built properties that may never get off its balance sheet. The order may have come more swiftly than authorities in Beijing may like. China’s leaders are still trying to postpone a permanent resolution of the housing crisis. The judgment now raises three unsolved questions, each of which has enormous implications for investment in China and the nature of its growth.

The first question is on the future of Hong Kong. The mainland has benefited tremendously from Hong Kong’s reputation over the past decades. Companies with businesses across China have been able to list and raise money in the former British possession, providing financiers with the comfort that any problems that they run into might be settled through a dispute resolution process conducted by a transparent judiciary and independent institutions under British common law principles that are familiar and investor-friendly. Yet there is every chance that the Evergrande judgment might not be applied swiftly in the mainland, if at all. If it turns out that Hong Kong courts do not really have sufficient legal power in the mainland, a benefit that Chinese companies have long taken for granted — the ease of raising capital through a hybrid offshore/onshore location — may evaporate.

The second is on how effectively the Chinese political system can deal with the complicated political economy of bankruptcy. In real estate, where debt-ridden local governments are often the silent partner in large investments, the question of who takes how much of a haircut is particularly complicated. Beijing has not done well when it comes to writing down politically sensitive loans in the past. Partly this is because of the opaque nature of the connections that lie behind successful or unsuccessful investment. But it is also because there may simply be little legal backing for write-downs of public money, or institutional capacity to make the determinations of solvency or seniority that are essential to the process. China needs to get the answers right here if it is ever to have a modern financial system.

The third question is on whether foreign capital will ever be treated properly in China, or it will always have subordinate status when push comes to shove. Investment fled the mainland in recent years, as President Xi Jinping’s economic nationalism has become increasingly strident and intrusive. But the hope has always been that, while investment on the ground may have turned unfavourable for foreigners, the capital markets could continue to serve as a conduit in which foreign and local capital could meet on equal terms. Any hint that Beijing is preventing resolutions that would lead to the repatriation of capital would be deeply unwelcome. Evergrande is being watched as a clue to the future of Chinese real estate. But its implications for the entire structure of the Chinese economy and its integration with the outside world go far deeper.