My Take | China Evergrande’s massive accounting fraud sheds light on the country’s property troubles

Massive accounting fraud at China Evergrande, once the country’s largest property developer, is adding insult to injury. While personal greed and the misconduct of its chairman Hui Ka-yan certainly led to the fraud, the saga points to deep troubles in China’s real estate market.

According to the Chinese Securities Regulatory Commission, China Evergrande inflated its sales by 564 billion yuan (US$79 billion) over a two-year period from 2019 to 2020, and fabricated its profits by 92 billion yuan. It is the largest known case of financial fabrication in Chinese history.

The regulator has imposed fines on the group and Hui, as well as banning the former chairman from accessing the capital markets for life. The administrative penalties are expected to be only the start of Hui’s punishment. As he has been placed under investigation but not yet charged, Hui is set to face legal consequences down the road.

The immediate implication is that China Evergrande did not have the money it once claimed, which has translated into additional costs and burdens for other stakeholders left to clean up the mess. China Evergrande was already a black hole, and the 564 billion yuan fraud revelation has just made it harder to cover up the hole. In a broader sense, the misdeeds at China Evergrande could imply structural problems with China’s property sector. The company is unlikely to be the only one that has cooked its books, and it’s an open secret that “marked-to-market” property assets can often be sold at deep discounts to their book value – if there are any buyers.

Developers, along with local authorities that control the land supply, are supposedly the biggest winners from China’s property market boom, but the reality is that both are badly indebted. On the one hand, Chinese municipal authorities have lavishly and quickly spent their windfall revenues from land sales. While the revenues from selling 70-year use rights for land are supposedly meant to support long-term local development, cadres often rushed to spend the money on airports, subways, museums, stadiums and parks.

In a similar way, the debt of Chinese property developers has also accumulated due to structural reasons: they have to borrow to maintain operations. China Evergrande’s fraud can be traced to its excessive borrowing, which was impossible to sustain after central Chinese authorities imposed the “three red lines” in 2019, which squeezed credit for developers, making it hard for indebted developers like China Evergrande to survive. It had to lie to creditors to keep going. Had China Evergrande admitted in 2019 that its revenues were halved from 2018, it could have collapsed then.