The Risks and Rewards of Playing Chicken With China

What are investors to make of all of this? If the company is going to default eventually, why make payments now? Especially given that Evergrande is also on the hook to deliver so many unbuilt apartments to Chinese families who are presumably Beijing’s priority?

The answer may lie, in part, with some unique features of China’s political economy. First, property rights in China are often malleable in practice. Companies and individuals that run afoul of Beijing, and sometimes even of local governments, can come under irresistible pressure to “donate” resources or accept large losses, as a more palatable alternative to extralegal detention, exit bans, or other forms of harassment. Second, because regulators aren’t effectively checked by the courts or parliamentary oversight, they often intervene in markets in aggressive and unpredictable ways to deter what they see as bad actors—for instance foreign speculators betting against the yuan.

The salience of the first point was highlighted on Tuesday when Bloomberg, citing anonymous sources, reported that Chinese authorities have told Evergrande’s billionaire founder

Hui Ka Yan

to use his own wealth to help settle the company’s debts. Bloomberg estimates that Hui is worth about $7.8 billion. That is a drop in the bucket of Evergrande’s liabilities—which added up to over $300 billion in June. But it could help settle some particular debts and avoid the perception of a rapidly escalating, uncontrolled meltdown. Hui has also agreed to inject some of his personal money into a bond-funded residential project, according to Reuters. It is unclear what the ultimate source of the funds for last Thursday’s interest payment was.

From Beijing’s perspective, forcing Hui to pony up personally could be attractive for several reasons. First, it metes out direct punishment, which has political appeal. Second, helping Evergrande stand behind some high profile debts injects some doubt into the calculus of speculators—both foreign and domestic—betting on a continual drumbeat of bad news and broader financial contagion. Evergrande’s long-run prospects look dim, but the fate of many other developers is still much less sure, and will depend substantially on market perceptions.

Chinese regulators have a long history of employing aggressive, unconventional measures to unravel perceptions of one-way bets they don’t like. Several times in 2016, while China was still battling significant capital outflows related to a previous debt and property crisis the year before, Chinese state-owned banks intervened heavily in the offshore yuan market based in Hong Kong—forcing the overnight rate for borrowing yuan over 60% and crushing speculators betting against the currency. Throughout late 2015 a “national team” of state-backed funds stepped into China’s stock market whenever Beijing felt the market was getting unduly bearish.

Beijing clearly has little desire to truly bail out struggling property developers—unless it has no choice—so such heavy-handed interventions are unlikely. But a little arm-twisting here and there could help slow the cycle of speculation and contagion, and buy time for some of Beijing’s own modest property easing measures to take effect. China’s economic planning agency met with several unnamed companies on Tuesday about their foreign debt holdings, according to a statement on the regulator’s website.

Many Chinese developers will no doubt continue defaulting—most recently, Modern Land on Tuesday. But investors should probably prepare for more confounding last-minute saves as well.

Write to Nathaniel Taplin at nathaniel.taplin@wsj.com