China and Evergrande rose together. Now one is about to fall

Realty major’s woes expose flaws in financial system

Xu Jiayin was China’s richest man, a symbol of the country’s economic rise who helped transform povertystricken villages into urbanised metropolises for the fledgling middle class. As his company, China Evergrande Group, became one of the country’s largest property developers, he amassed the trappings of the elite, with to some of the most powerful people in Beijing.

China is threatening to take it all away. The debt that powered the country’s breakneck growth for decades is now jeopardising the economy — and the government is changing the rules. Beijing has signalled that it will no longer tolerate the strategy of borrowing to fuel business expansion that turned Xu and his company into a real estate powerhouse, pushing Evergrande to the precipice.

Unpaid bills

Last week, the company, which has unpaid bills totalling more than $300 billion, missed a key payment to foreign investors. That sent the world into a panic over whether China was facing its own so-called Lehman moment.

Evergrande’s struggles have exposed the flaws of the Chinese financial system — unrestrained borrowing, expansion and corruption. The company’s crisis is testing the resolve of Chinese leaders’ efforts to reform as they chart a new course for the country’s economy.

If they save Evergrande, they risk sending a message that some companies are still too big to fail. If they don’t, as many as 1.6 million homebuyers waiting for unfinished apartments and hundreds of small businesses, creditors and banks may lose their money.

“This is the beginning of the end of China’s growth model as we know it,” said Leland Miller, CEO of the consulting firm China Beige Book.

Evergrande lured new homebuyers by selling them on more than just the tiny apartment they would get in a huge complex with dozens of identical towers.

Xu grew Evergrande from a small outfit with fewer than a dozen employees into China’s most prolific developer through a combination of rampant borrowing and elite political connections.

Close to power

Early on, Xu cultivated relationships with the family members of some of China’s most senior officials. In 2002, listed among the company directors in Evergrande’s annual report was Wen Jiahong, the brother of China’s vice premier, Wen Jiabao. Wen Jiabao became

China’s premier the next year. Not only was his brother an Evergrande director, but he also once controlled the secondbiggest stake in the fast-growing company.

When China’s economy began to cool down, the damage caused by Evergrande’s voracious appetite for debt became impossible to ignore. There are nearly 800 unfinished Evergrande projects in more than 200 cities across China. Employees, contractors and homebuyers have held protests to demand their money. Many fear they will become unwitting victims in China’s debt-reform campaign.

“This is a damned if they do, damned if they don’t situation,” said Michael Pettis, a finance professor at Peking University. “Beijing should have acted 10 years ago.”

In August, Evergrande executives were summoned by regulators, who warned them to keep the company’s debt under control.

Amid concerns that an Evergrande demise could spread through the Chinese economy, Beijing unleashed a flood of capital into China’s banking system last week, a move that was seen as an attempt to calm market jitters.

“This is a much broader problem than Evergrande itself,” said Logan Wright, a director of China research at the consulting firm Rhodium Group.