In 2019, visitors from China accounted for 30% of all inbound tourists to Japan.  

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Source: JTB Tourism & Research Consulting

Chinese tourists showed up by the plane and bus load, spending so much money that Japanese news agencies created a new word for their shopping habits; baku-gai, which means explosive shopping.

The hotel industry along with AirBnB operators were flush with cash from inbound tourism and investment banks began creating tourism oriented J-REITs dedicated to hotel operations in Japan.

Throughout the pandemic, buyers have been snapping up underpriced Japanese hotels hit hard by lockdowns as a way to position themselves for the predicted rush back to 2019 inbound tourism levels.  

If Evergrande proves to be the catalyst for further damage to the Chinese consumer and economy, Japan’s hospitality industry could have 30% less tourists to serve even if all other regions come back to 2019 inbound levels.

That is a big “if”.

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Evergrande in all likelihood will fail.  Due to the Chinese real estate developer’s apparent inability to service debt payments coming due this week, stocks, bonds and cryptocurrencies sank sharply as investors were wary of the contagion this failure could induce on the global economy.

At the time of publishing, most analysts have started to find consensus that these moves presented a great buy-the-dip opportunity with most asset classes showing signs of some recovery.  Whether this lasts time will tell. 

To understand the context of what spooked global investors about Evergrande in the first place, one needs to understand the importance of the property sector to the Chinese citizen and the overall Chinese economy.  

Economics Explained, an Australian YouTube channel dedicated to simplifying complex economics into short, watch-while-eating-lunch videos.  

On August 21st, the channel released the below explaining why Chinese debt levels should have the rest of us worried.  

Despite the doom-and-gloom ending, the video aged well given Evergrande’s situation.  

The developer currently owns 1,300 projects in more than 280 cities across China, annually employs millions of people directly or via sub-contracting work, and has debts of more than $300 billion.

Beijing for its part seems happy to let the developer fall, sending a message to the remaining firms in the sector, and the overall economy, that no one is too big to fail.  

Indeed, other developers are scrambling to shore up their balance sheets to fall onside of Beijing’s “Three-Red-Lines” policy. 

Set by Beijing and the Ministry of Housing in 2020 to try and cool the overheated property market, the Three Red Lines represent a set of financial criteria that developers must demonstrate before they can qualify for higher levels of debt.

Evergrande fails on all three red lines by a wide margin, despite spending most of 2020 and 2021 trying to bring themselves onside. 

Source: Financial Times

Between Beijing and the property sector, the consumers are the ones caught in the middle.  Evergrande funded development for projects using fully paid pre-sales with mortgages borrowed by consumers.  

This isn’t an Evergrande problem.  In China this is how building projects are funded as a general practice; upfront sales prices paid in full prior to breaking ground on a project. 

When the government introduced the red lines policy, Evergrande struggled to raise enough liquidity needed to meet regulations, thereby cutting themselves off from high levels of bank borrowing they had previously relied on. 

In a sign of how desperate Evergrande was to raise money, their sales people sold customers newly created wealth management funds that never went to any wealth creation activities on behalf of clients, but to plug holes in Evergrande’s balance sheets, according to the Financial Times.

So, the protestors outside Evergrande’s offices are a mixture of wealth management clients and property buyers, all looking for their money back.

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If it comes to light that Evergrande wasn’t the only overly debted developer that can’t fall into the red lines criteria, more developers will fail and more consumers will be hurt. 

Seeing as how the real estate sector together with allied industries make up roughly 20% of China’s annual GDP, any consumer confidence crises could have large, knock on effects to the rest of China’s economy potentially causing a rise in unemployment.  

If unemployment spikes, then overleveraged, out-of-work homeowners could find themselves unable to pay their mortgages. 

Rising unemployment with cooling demand for property could lead to falling real estate prices leaving owners with loans greater than what the property can sell for. 

This is called negative equity and it is the exact place many Japanese homeowners found themselves in when the bubble burst in the early nineties.  

That bubble, like China’s current predicament, was fueled by overly high debt levels which the Bank of Japan then intentionally burst by raising interest rates.

Whether this was a correct decision or not is debatable but one thing is agreed on by all; no country wants Japan’s decades long stagflation that followed.  

Beijing’s next moves, or lack thereof, will tell how well the government can protect their consumers in the likely fallout once Evergrande defaults.  

That, in turn, can give Japan’s hospitality sector some sign of whether 2019’s largest inbound tourist group will return anytime soon.