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Explainer | The Evergrande crisis and how it can spiral into a global financial crunch

Chinese property giant Evergrande finds itself caught with debt of $300 billion and declining sales. Investors worldwide have been spooked by the possibility of a default that could trigger a global financial crisis.

China’s property companies are big drivers of its economy – contributing nearly 30 percent as per estimates by the National Bureau of Economic Research working paper. (Image: Reuters)

China’s property companies are big drivers of its economy – contributing nearly 30 percent as per estimates by the National Bureau of Economic Research working paper. (Image: Reuters)

Once a company that allowed ‘working families to afford apartments’, China’s Evergrande has now become synonymous with an impending global financial crisis. Offices of the property giant are swarmed by investors, employees and suppliers – some of whom claim as much as $1 million owed, in a rare show of protests in China. If you are wondering what is the fuss about Evergrande and why it has triggered worries across the global markets, here is a primer that answers all the essential questions.

What is Evergrande?

Evergrande is China’s second-largest property developer based in Guangzhou, the capital of Guangdong province in the south of the country.

Riding the wave of China’s property boom, Evergrande expanded to 280 cities and became the face of the country’s real estate sector, owning more than 1,300 real estate projects.

China’s property companies are big drivers of its economy, the second-largest in the world. Real estate contributed almost 30 percent to the Chinese economy, according to the National Bureau of Economic Research.


Why is Evergrande in the spotlight?

Evergrande accumulated debt of $300 billion as it acquired assets and expanded over the years. However, property sales have been declining for months and the company said recently that they will possibly continue to fall, constraining its cashflow further.

In addition to bondholders, the company owes 667 billion yuan ($103 billion) to construction companies and other business creditors, AP reported.

Banks stopped lending to the property developer after its cashflow slowed and rating companies downgraded the company, citing liquidity concerns.

Evergrande has been struggling to pay suppliers. It even told investors that it could default on debt.

The company has offered to repay debt in the form of property and parking spaces – a move rebuffed by now distrustful investors who say they want their cash back.

How did this happen?

Evergrande was caught out by new limits that China’s regulators imposed on real estate-related borrowing as part of the Communist Party’s campaign to reduce reliance on debt, AP reported.

The crackdown on property developers is what sapped liquidity from Evergrande’s bonds, MarketWatch reported. Some of the firms with holdings in Evergrande bonds are Ashmore Group, BlackRock, HSBC Holdings and UBS Group.

According to some experts, blind trust has proved to be costly.

Zhiwu Chen, professor at the University of Hong Kong, told AFP that the debacle shows how “lenders and other suppliers of capital have not done their job in exerting proper checks and balances on Evergrande.”

Evergrande also tied money to launching its own electric vehicles but is making “no progress” in selling stakes to outside investors, it added.

What’s the immediate concern?

As per a Reuters report, Evergrande is due to pay interest of $83.5 million on bonds on September 23, with a grace period of 30 days. This will be a “major test” of whether the company will pay or the authorities will decide on a bailout plan.

“Whether Evergrande can make payments, and if not, whether the authorities will bail it out – those are the immediate questions,” Masahiro Ichikawa, chief strategist at Sumitomo Mitsui DS Asset Management, told Reuters. “In the longer term, we could see slower Chinese growth hurting surrounding countries.”

Some financial analysts agree that Beijing will intervene to protect buyers of unfinished apartments and protect consumer confidence.

Effects already in motion

In what could be a preview of a likely impact, the looming crisis at Evergrande pulled down global share markets.

As of September 21, global stock markets grappled with contagion fears – China, Taiwan and South Korean markets were jittery, ranging near flat to an almost 2 percent drop in Japan. S&P 500 futures rose 0.3 percent following the index’s biggest fall in two months overnight and the Chinese yuan rebounded in offshore trade to recover Monday’s losses.

Shanghai-based property magnate Zhang Yuanlin lost over $1 billion in the Evergrande panic across Hong Kong trading floors.

Chairman of Sinic Holdings Group, Zhang’s net worth plunged from $1.3 billion in the morning on September 20 to $250.7 million by the afternoon. His firm was forced to halt trading in Hong Kong following an 87 percent slump in its share price.

Three major benchmark stock indexes – the S&P 500, Dow Industrials and Nasdaq Composite had their worst one-day drop in more than two months – with Evergrande cited as the biggest risk.

How could the crisis affect the global markets?

Some analysts fear that a default by Evergrande could topple China’s property market, sending ripples worldwide. Many recalled the Lehman Brothers financial crisis of 2008.

RaboResearch said there are “whispers this could be China’s ‘Lehman moment’ while Michael Arone, chief investment strategist at State Street Global Advisors, warned the development is “too big to ignore” as the market is at a “seasonally challenging time and there’s just a lot of uncertainty.”

Many are concerned that losses would force bondholders to sell other investments or shed riskier assets to raise cash, hurting markets that may seem unrelated. The catchphrase being thrown about is “contagion,” with many worried about tightly connected global markets.

Not all analysts agree. Analysts at Barclays called such speculation “far off base” while acknowledging the probable spillover effects with economic implications.

“But a true ‘Lehman moment’ is a crisis of a very different magnitude” and Chinese authorities would need to make a series of policy mistakes in response to the crisis for this to be of the Lehman level, they added.

SocGen economists said investors seem to be “differentiating between safe and risky borrowers,” which at the moment would limit the spillover to the wider financial market. On the whole, the sector’s investment-grade index also remained largely stable, they added.

They agreed largely that China’s situation is “very different” as the property sector’s links to the financial system are “not on the same scale” and noted that the capital markets are not the primary means of funding. The message is that as long as the regulators step in, the situation is manageable.

“The lesson from Lehman was that moral hazard needs to take a back seat to systemic risk,” Barclays analysts wrote.

What does it mean for the Indian markets?

The Indian markets have so far been largely unaffected by the Evergrande crisis.

Gaurav Garg, head of research at CapitalVia Global Research, said Indian equity benchmarks made an optimistic start on September 21 despite weakness in global peers due to Evergrande. The benchmark BSE Sensex advanced 0.88 per cent on September 21.

Sandeep Matta, founder of TRADEIT Investment Advisor, said gold prices have “built some speculative interest and closed moderately high” amid the Evergrande-induced sell-off in the global markets.

Kotak Mahindra Bank managing director Uday Kotak on September 21 likened the Evergrande crisis to the Infrastructure Leasing and Financial Services collapse in India in 2018 and termed it “China’s Lehman moment.”

Siddhartha Khemka, head - retail research, at Motilal Oswal Financial Services, noted that weakness in the global markets and Asian equities have made investors cautious as they await the outcome of the US Federal Reserve and European Central Bank meetings this week.
Jocelyn Fernandes
first published: Sep 21, 2021 04:17 pm

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