China’s central bank and one of its largest state lenders are holding emergency talks over whether to bail out a defaulting real estate developer.

The talks come barely a week after Premier Li Keqiang dubbed defaults “unavoidable”, highlighting the tightrope officials tread between courting moral hazard and undermining the debt-laden financial sector.

In a case which offers a microcosm of the cracks emerging in China’s shadow banking system, Zhejiang Xingrun Real Estate, the provincial developer, had been offering usurious rates of interest to individuals after being shut out by conventional banks.

Officials from the government of Fenghua, a town in eastern China with a population of about 500,000, the People’s Bank of China and China Construction Bank, which was the main lender to the developer, were on Tuesday thrashing out ways to repay the company’s Rmb3.5bn ($566m) of debt.

Local government officials were keen to play down Xingrun’s fate, which quickly added fuel to markets jittery after Chaori Solar, the solar cell maker, this month became China’s first bond default.

Hong Kong-listed real estate stocks fell by half a per cent in morning trade on Tuesday in a market that was up half a per cent.

The “situation is not that serious yet”, said a Fenghua local government official who only gave her surname Wu. Failure of a small property developer is not unusual in China or even in Zhejiang Province, where Xingrun is based.

The company appears to have stopped functioning after its chairman and his son were arrested in November and January for suspected “illegal fundraising” and engaging in usury, according to state media reports.

In a practice that is illegal but has become common in China’s shadow banking sector, the company took deposits from individuals who were offered annual interest rates of between 18 and 36 per cent.

Although Xingrun’s problems appear to stem mostly from mismanagement and alleged illegal activity, the company’s demise could be a warning sign of problems to come in China’s overheated property sector.

Over-investment in the sector is China’s top risk this year and next, say analysts at Nomura Securities.

“The risk is particularly high in third- and fourth-tier cities, which account for 67 per cent of housing under construction in China in 2013,” said Zhiwei Zhang, an economist at Nomura.

“This risk does not seem fully recognised in the market partly because data are not readily available for these cities, and some investors may be misled by the boom in first-tier cities.”

Real estate construction has long been the main driver of the Chinese economy, accounting for about 16 per cent of gross domestic product, a third of all investment in the country and about 40 per cent of government revenues last year.

Property loans, including mortgages and loans to developers, accounted for a quarter of all new formal bank loans last year and property developers are also major borrowers in the shadow banking sector.

After years of rising prices and fevered investment in the sector, most developers are not prepared for the possibility that oversupply could see prices level off or even collapse.

In the case of Xingrun, the company appears to have been hammered by the fact that local prices for land have collapsed by a third, while prices for individual apartments and houses in Fenghua have dropped by more than half since their peak in early 2011.

Prices of land and housing in major cities are still rising, with average new home prices in China’s 70 largest cities up 8.7 per cent in February from a year earlier, easing from a 9.6 per cent rise in January, according to official data published Tuesday.

Meanwhile, a local government 1,350km away in Shanxi province may have given a lifeline to Haixin Steel, according to steel traders. Haixin employees would not confirm the talk, and the local government could not be reached for comment. Haixin is still operating, albeit at a low rate, after it failed to pay back maturing loans this month.

If Haixin were allowed to fail, it would be a test of how much tolerance Beijing has for defaults that could ripple into the broader regional economy.

The steel mill is embroiled in a tangle of triangular debts with local companies and coal suppliers, and has invested in a local securities group and a credit guarantee company that would have helped other companies secure loans.

It contributes nearly 60 per cent of government revenues in its home township of Wenxi, near Yuncheng.

Additional Reporting by Gu Yu and Owen Guo

Get alerts on Chinese business & finance when a new story is published

Copyright The Financial Times Limited 2019. All rights reserved.
Reuse this content (opens in new window)

Follow the topics in this article