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Just one step in fixing China’s debt crisis is the order to liquidate property giant China Evergrande.

The recent order from a Hong Kong court to liquidate China Evergrande, the world’s most indebted real estate developer, is being viewed as just a preliminary step toward resolving a looming debt crisis that’s casting a shadow over financial markets and the Chinese economy.

Evergrande is grappling with a colossal debt of $340 billion, but it’s uncertain whether this week’s court order will have any real impact in mainland China, where the company and most of its assets are situated. In China, local lenders already have significant claims on these assets, making it likely that they’ll be given priority over international creditors.

However, the court’s liquidation order doesn’t address the fundamental issue of trust that’s been plaguing China’s financial markets.

According to Brock Silvers, managing director of Kaiyuan Capital, the appointed liquidators may find it relatively straightforward to go after offshore assets, but Evergrande’s offshore holdings are sparse compared to its extensive onshore assets. As a result, the authority of liquidators in mainland China isn’t recognized, leaving international creditors in a precarious position.

Chinese authorities have made it clear that their primary focus is on satisfying claims related to prepaid housing projects that developers like Evergrande have failed to deliver. Once these claims are addressed, attention will shift to onshore creditors, leaving little room for offshore creditors.

These concerns were underscored by market reactions in both Hong Kong and Shanghai following the liquidation order. The Hang Seng index dropped by 2.3%, and the Shanghai Composite index fell by 1.8%. Major property companies like Country Garden and Sunac China Holdings experienced significant declines in their share prices.

The ongoing property crisis, coupled with the lingering effects of the COVID-19 pandemic, is expected to dampen China’s economic growth to below 5% this year.

While Evergrande’s financial woes are a significant contributor to the current challenges, China’s financial system faces broader issues beyond the property sector. Many financial institutions and local governments across China are struggling with debt burdens.

Overall, China’s property debt amounts to approximately 60 trillion yuan ($8.9 trillion), nearly half of the country’s GDP in 2022, according to the Swiss Re Institute.

Despite these challenges, China’s financial system is less susceptible to external factors compared to other economies. Mortgage foreclosures are less common, and Chinese homebuyers typically make substantial down payments.

To address the mounting pressure on the real estate market, the government has implemented measures to increase financing availability while curbing loans for new property investments. Additionally, banks have been instructed to manage risks more effectively.

While China’s banking sector remains stable, the wider financial system faces challenges, particularly with local governments grappling with substantial debt and non-bank financial institutions heavily exposed to property loans.

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