China’s second-largest property developer, Evergrande Real Estate Group, is in deep waters owing to the astronomical debt of more than $300 billion. The company has been scrambling to raise funds and pay their dues off but in vain. Numerous concerns are accruing as this company’s default could spell disaster for China’s property market. The news not only affected China’s social and economic equilibrium but also triggered chaos across global markets.
Read on to understand what went wrong, why people dread this potential default, what is the Chinese government doing and, what impact did it have on the global markets? But first, let’s see how big a deal Evergrande is!
Evergrande: A real-estate conglomerate
Evergrande commenced in 1996 in the Chinese province of Guangzhou, selling bottled water and later turned to pig farming. It today owns 1300 real-estate projects in over 280 cities. Founded and headed by the chairman Hui Ka Yan, Evergrande became the “poster boy” of the Chinese Real Estate boom. According to the National Bureau of Economic Research, the real estate sector forms about 30% of the Chinese economy. Therefore, real estate has played a significant role in boosting China’s economy, not only before the pandemic but also in the post-pandemic phase.
Evergrande successfully sold house-ownership dreams to working middle-class families, such that every fourth house sold in China belongs to Evergrande. Over time, Evergrande also diversified into other businesses like entertainment, EV production, life insurance, theme park construction, TV & Films, mineral water, food and baby products’ production. With a sales revenue of over 8 lakh crores in FY 21, the company became a part of the Global 500. It also boasts of dealing with over 38 lakh contractors and sustaining about 1.2 lakh employees.
So now the question is that if the company seems so profitable-
What brought Evergrande into the spotlight?
On Tuesday, September 21, a letter sent by Evergrande’s CEO Xu Jiayin to his employees leaked on social media. The letter hinted towards the company being in trouble and stated that it would get past this “darkest moment” with support from its leaders and employees. The news about Evergrande’s $300 billion debt, leaked in mid-September, immediately drew reactions from global markets. Alongside, investors, employees, and suppliers began to swarm Evergrande’s offices, demanding answers and clarity about the company’s financial state.
The story behind this snowballed debt
Ever since the liberalization of China’s real-estate industry in late 1990’s, prices of real estate in China have been on a roll. The flourishing industry attracted many businessmen; one among them was Mr Hui Ka Yan. The relaxation of house-ownership policies by the banks and central government encouraged property developers to heavily invest in land and build apartments using debt as their means of financing.
As land is limited in supply while demand keeps increasing, the prices of real-estate kept ballooning. Generally, people view property as a safe-haven investment. However, the economic boom induced in China due to the constant development of new houses, encouraged investors to park their money in real-estate, converting houses into speculative assets.
Price bubble in the housing market over time in Shanghai, China
In 2009, when the world was recovering from the GFC, Evergrande was riding at the peak of the real-estate boom in China. Instead of repaying their borrowings, the company diversified into new businesses and even bought a sports team, Guangzhou Evergrande FC, which is among the best-known football clubs in China. The company has taken loans from about 171 banks and over 121 financial institutions. As a result, Evergrande grew to become the most indebted real-estate company. The founder Mr Hui Ka Yan became the richest Asian with a net worth of $43 billion (2017). He was also declared the 53rd richest person on Forbes Billionaires 2021 list.
Globally, China accounted for over 57% of the $11.6 trillion increase in household borrowing over the decade through 2019 according to the Bank for International Settlements Data (while U.S. accounted for 19%). The central government and banks have made multiple attempts to curb this unreasonable upward climb in the property prices. One such attempt made in the form of the “The Three Red Lines” (launched in August 2020) put Evergrande in the red.
The Three Red Lines Policy
In April 2021, Evergrande failed this test, which put a ban on the flow of funds to Evergrande from ‘bank borrowings’ route. However, Evergrande didn’t stop there. They commenced the sale of ‘wealth management products’ (WNP) aggressively, to raise money directly from the people. Employees were given unachievable targets and compelled to put their life savings in these financial products. They allured close to 70,000 people by promising above-average returns on financial products put under the ‘fixed-income’ category. In this way, WNPs became the new source of cash-flow for Evergrande.
However, in the beginning of September, some credit rating agencies downgraded the ratings of Evergrande. The company was also not successful in selling its interests in their EV company to outside investors. A progressive slowdown in the property markets and tapering demand for new houses only worsened the company’s financial position. Since January 2021, the stock prices of the company have tumbled by 81%.
Share Price of Evergrande fell 81% in this YTD
Currently, Evergrande has about 800 unfinished projects, unpaid suppliers and close to a million home buyers. In September, the company missed two coupon bond payments, stirring large-scale protests by its retail investors. According to the terms of its sales prospectus, the company is currently serving the 30-days grace period to clear the dollar bond coupons, failing which it will be labelled in default.
Immediate Impact on Global and Indian Markets
Markets globally saw a spillover effect as a result of the news. Key indices across Asia-Pacific tanked sharply. The richest Global 500 people lost about a combined $135 billion. The metals segment of the Indian stock markets plummeted sharply. The sale of metals, steel, iron ore intensified due to the restrictions on industrial activities imposed in China. Stocks like JSPL, Tata Steel, SAIL and NMDC dropped to the tune of 5-10%. Apart from the immediate reaction, the Indian Stock Markets have largely been unaffected by the crisis.
Top Indian metal stocks plummeted sharply on Monday, September 20, in response to the news.
The way forward
The firm has hired financial advisers Houlihan Lokey and Admiralty Harbour Capital to help assess the situation and explore feasible solutions to ease the liquidity issue. Since China is a state-owned economy, some analysts believed that the state will bailout the company. To ease the fears of retail investors, the central bank of China (PBOC) injected some cash into the banking industry. However, a complete bailout seems difficult as PBOC has only promised to ‘protect the interest of retail investors’ by intervening in case of a contagion and urged Evergrande to find a way to pay off its short-term dues.
On a positive note, the distressed company has repaid a 10% installment of the WMPs due earlier, on Thursday, 30th September. This payment was in line with a repayment schedule announced on its website. The company has also been successful in selling a 19.9% stake of Shenging Bank for $1.5 billion. However, the lender has demanded the sum to be used strictly for setting off debts and not investing in new projects.
This case has already thrown light on the darker side of China’s ballooning and uncontrolled debt. If the company defaults, it will certainly have a ripple effect throughout the Chinese economy, causing both- financial disruption and social turmoil. Impact of such a default on global markets can only be guessed. Only time can tell if the Evergrande Crisis will bring as much trouble as the collapse of Lehman brothers brought!