One of China’s main engines for growth has been its property sector. The rapid urbanisation allowed developers to build houses and sell them at a rapid pace. Today, the sector contributes to 30 per cent of the country’s gross domestic product (GDP). Raising debt to finance these projects was not a concern as the government, which controlled the banks, was ready to funnel money into the sector.

However, smaller cities have seen a slowdown in growth, even oversupply, as millions of homes lie vacant — the infamous ‘ghost cities’ of China. The rapid debt-fuelled party in the property sector has lasted for more than two decades despite facing years of criticism.

The total credit shelled out to non-financial companies in China has formed 160 per cent of the country’s GDP as of September 2020. This is almost twice that of American corporations, whose debt to GDP value has lingered around 60 per cent to 80 per cent.

The highly leveraged nature of the economy makes it quite fragile. However, the Chinese Communist Party (CCP) has realised its folly and is now trying to rein in the boom. In order to make the economy more resilient, the CCP embarked on a project to curb heavy borrowing in the sector.

The ‘three red lines’ referred to conditions placed on property developers to rein in their credit, and stop the economy’s heavy dependence on infrastructure and real estate. The three conditions included a limit on net debt to equity, liabilities to assets and cash to short term debt.

Depending on the company’s metrics in relation to each of these conditions, banks would decide the incremental amount of debt. Any company that failed on all metrics would not be issued more debt.

The Evergrande Group had failed on all of these metrics, according to the figures in the financial reports released by the company for its Cayman Islands investors. The failure to meet the financial standards, prompted the company to sell stakes in group companies and get them listed on the exchanges.