EVERGRANDE CRISISChina’s Lehman Brothers Moment?

-Penned by Priyank Tantia & Sakshi Sharma

INTRODUCTION

Evergrande, a Chinese real estate conglomerate, is apparently saddled with a massive debt load of US$305 billion (£220 billion). Angry protests have erupted at its offices, shares have plummeted, and the financial world’s eyes are on its future with bated breath. Simply put, Evergrande’s condition is critical. And the company’s problems might have far-reaching ramifications for individual Chinese homeowners, businesses, and the global economy, in addition to the company’s own problems.

BACKGROUND

By sales, the Evergrande Real Estate Group is China’s second largest property developer. On the Fortune Global 500, it is rated 122nd. It is based at the Houhai Financial Center in Nanshan District, Shenzhen, Guangdong Province, China, and was founded in the Cayman Islands. Evergrande, formerly known as the Hengda Group, was formed in 1996 by Xu Jiayin in the southern Chinese city of Guangzhou, at a period of rapid urbanisation in the country. It mostly caters to upper- and middle-class residents. It became the world’s most valuable real estate corporation in 2018.

Operations and business interests

In 22 locations, the Evergrande Group holds 565 million square metres of development land and real estate projects. Evergrande also owns the “Hengda children of the world” and “Hengda water world” theme parks, as well as a massive tourist complex in Hainan called “Chinese island of Hainan to spend.” In addition, it purchased Guangzhou Evergrande F.C. in 2010 and invested substantially in acquiring top players. The team won the AFC Champions League in 2013 under the leadership of Marcello Lippi. Evergrande began work of the Guangzhou Evergrande Football Stadium in Xie Village, Panyu District, Guangzhou, on April 16, 2020. Evergrande Group is present in the finance industry as well. Evergrande purchased a 50% ownership in Sino-Singapore Great Eastern Life Insurance Company for $617 million in November 2015 and renamed it Evergrande Life. It is also a shareholder in Shengjing Bank. Consumer wealth management products have also been sold by Evergrande.

The Fall of the mighty Empire

Every now and again, a corporation gets so large and complex that governments are concerned about the consequences for the rest of the economy if it fails. For China, Evergrande became that corporation. Evergrande has the dubious distinction of being the world’s most indebted real estate developer, and it has been on life support for months. In recent weeks, a relentless barrage of bad news has accelerated what many experts predict will happen: collapse. It is running out of funds and time, according to rating agencies such as Fitch, Moody’s, and S&P. It is in debt to the tune of more than $300 billion, with hundreds of incomplete residential complexes and irate suppliers shutting down construction sites. The corporation has begun to pay past-due obligations by handing over unfinished homes, and it has even asked staff for financial assistance. It is now considered as a shaky threat to China’s major banks.

Evergrande profited from China’s massive property boom, which urbanised enormous swaths of the country and resulted in housing accounting for roughly three-quarters of all household wealth. This positioned Evergrande at the epicentre of power in an economy that had come to rely on the real estate industry for supercharged growth. Xu Jiayin, the company’s billionaire founder, is a member of China’s People’s Political Consultative Conference, an exclusive group of politically connected advisers. Creditors were more likely to continue providing money as it grew and expanded into new businesses because of Mr. Xu’s ties. Evergrande, on the other hand, eventually accumulated more debt than it could handle.

Evergrande might have been able to continue if it hadn’t run into two issues. First, Chinese officials are cracking down on property developers’ risky borrowing habits. It has been obliged to start selling some of its vast business empire, which isn’t doing so well. Second, China’s property market is faltering, and new apartment demand is declining. The housing market boom has “shown signals of a turning point,” according to the National Institution for Finance and Development, a renowned Beijing think tank, citing poor demand and sluggish sales.

Evergrande has been able to raise a lot of money from pre-sold units that haven’t been finished yet. According to a Barclays estimate, It has almost 800 incomplete projects across China, with as many as 1.6 million people waiting to move into their new houses.

Impact on the World Economy

The Evergrande Crisis has caused a credit crunch implying that the company cannot borrow and expand further, which is leading foreign investors to pull out of investments and see China as a less attractive investment option. The company is now forced to use the money raised by selling wealth management products to retail investors to plug the funding gaps.

This credit crunch has been exacerbated by the ongoing COVID crisis, which in turn is leading people to speculate if this is going to turn as bad as the 2007-08 financial crisis. The popular opinion, though, remains that the Chinese government would bailout the company and prevent the Lehman-brother like fallout that country as well as the world is headed towards.

The cause of concern currently is the domino effect of credit events that is bound to kick in due to the crisis. According to strategists at Swiss investment bank UBS, Evergrande’s liabilities are said to involve more than 130 banks and over 120 non-banking institutions worldwide. The crisis is going to affect both banks and non-banks with large exposure to Evergrande, which could potentially be forced to restructure. This restructuring would then create spill over into other Chinese financial assets and drive underperformance of financials in particular across both DM (developed markets) and EM (emerging markets) credit/equity markets, led by those with direct exposure either to Evergrande itself, its subsidiaries or its creditors.

There are also serious implications for the property market worldwide if the crisis persists. Evergrande Group’s total liability is $313 billion in property market, which is 6.5 per cent of the total liability of the Chinese property sector. In terms of total offshore bonds outstanding, Evergrande has $19 billion, which is equivalent to roughly 9 per cent of the total offshore bond market. If the crisis is left unmitigated, there would be systemic risk to the property market worldwide.

From an Indian perspective, possible economic fallout from the Evergrande episode could impact sectors like metals and chemicals, as China is a huge consumer. There could also be a possible impact on a lot of raw materials coming from China. Even if the Evergrande issue doesn’t lead to a wider contagion, since its debt is not too widely held, there is always a risk of markets correcting sharply due to such episodes, especially after a huge rally this year. The BSE Sensex, for instance, has gained 55 per cent in the past year. “Investors have to be cautious since markets are richly valued and therefore, vulnerable to corrections,” said VK Vijayakumar, chief investment strategist at Geojit Financial Services.

The effect of this is not limited to the Indian share market. The Indian forex market might also come under pressure due to the crisis surrounding Evergrande. INR is still an emerging currency and has been facing considerable depreciation in the past and if the Chinese Government do not come forward to bail out Evergrande, then rupee could see further volatility and depreciation.

There have been various speculations about the probable solution to this crisis. In this current scenario, Chinese government could take a leaf out of India’s approach to IL&FS crisis that happened recently. Indian government had acted fast and swiftly. They also made sure that they stabilised the Indian Stock and Forex Markets. Thus, the World expects that Chinese Government would learn from its southern neighbours, India, and would take similar measures to ensure that the Evergrande crisis do not spiral out of control.

REFERENCES

https://www.theguardian.com/business/2021/sep/25/how-fall-of-property-giant-evergrande-sent-a-shockwave-through-china

https://www.indiatoday.in/business/story/china-evergrande-crisis-global-stock-markets-in-panic-mode-1855467-2021-09-21

https://www.dnaindia.com/explainer/report-dna-explainer-how-downfall-of-china-second-largest-property-developer-evergrande-will-impact-global-markets-2912284

https://www.cnbc.com/2021/09/20/evergrande-debt-collapse-could-have-domino-effect-on-china-properties.html

Aishwarya | Ayush | Bhavya | Jayati | Shivika | Varshita

Apoorva | Jeevan | Priyank | Rajdeep | Sakshi | Shelly | Varnika

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