Troubles at one of China’s biggest real estate companies has triggered speculation whether it could be the ‘Lehman Brothers moment’ for the world’s second biggest economy, drawing parallels with the collapse of the US bank in 2008 amid the bursting of the housing bubble that sparked a global financial crisis. Stock markets across the world have already registered dips on the back of the news from China, although experts say that the Evergrande situation is unlikely to develop into a full-blown decline in markets globally. Here’s what you need to know.
What Has Happened?
A crisis has been brewing at Evergrande, China’s second-largest real estate company for months and the company had warned that it was facing a liquidity crunch that has left it without money to pay off its debt obligations, which cumulatively stand at over $300 billion.
The company, which is being described as “the world’s most indebted property developer", has been downgraded multiple times by ratings agencies and has seen its share price plummet nearly 80 per cent this year. The risk that Evergrande would likely default on upcoming payment obligations was highlighted in September when Chinese authorities reportedly told banks to not expect the company to clear interest dues.
A blow to one of the biggest players in its real estate sector would have implications for the wider Chinese economy. While the real estate sector accounts for about 30 per cent of China’s GDP, the assets of Evergrande alone are nearly equal to about 2 per cent of China’s GDP. Further, the company makes up about 4 per cent of total property sales in China, but it has pointed to a slowdown in sales as the primary reason behind its present troubles.
What Is Evergrande?
The company was founded in 1996 in the southern Chinese city of Guangzhou by Xu Jiayin and rose to become one of the biggest real estate developers in China with a focus on building residential property. It is reported to be behind over 1,300 projects spread across 280 cities in China.
It has over 1.2 lakh employees and also works with 38 lakh contractors. It is also a Fortune Global 500 group enterprise and is listed in Hong Kong, reporting sales of $110 billion last year.
As the company looked to diversify out of real estate it bought the Guangzhou Evergrande soccer team in 2010, which has now built the world’s biggest soccer school at a cost of $185 million. Evergrande is also building a lotus-flower shaped soccer stadium at a cost of $1.7 billion that will reportedly seat 100,000 poeple.
It also has a theme park division and runs the Evergrande Fairyland.
How Did It Get Here?
Experts say that it was the company’s expansionary moves that have now come to bite it. It now operates businesses across categories like electric vehicles, sports, theme parks, food and beverage, bottled water, groceries, dairy products. Reports say that its debt ballooned when it borrowed heavily to fund its other projects and also sold apartments at low margins in hopes to quickly raise cash.
Part of its problems are also being attributed to a crackdown launched by China against businesses with officials bringing in rules last year to rein in the borrowing costs of developers, placing ceilings on debt vis-a-vis a firm’s earnings and asset and capital levels. It said it has been trying to reduce its debt through asset and equity sales, but has reported that it has failed to find buyers.
What Does It Mean?
Most people who were working at the time would remember the global financial meltdown of 2007-2008, triggered by the massive defaults on loan repayments by American property buyers that exposed aggresive, and questionable, credit practices at US lenders.
The Evergrande situation though may not translate into a global crisis as experts point out that Chinese authorities would likely step in to manage the fallout.
“Evergrande is such an important real estate developer, and it would be a strong signal if anything happened to it. I believe there will be some supporting measures from the central government, or even the central bank, trying to bail out Evergrande," Dan Wang, an economist at Hang Seng Bank, was quoted by CNBC.
Evergrande has warned of a “cross default" situation wherein failure on its part to clear dues would lead to knock on effects, eventually sparking a “contagion" that can affect the financial system.
Uday Kotak, the CEO of Kotak Mahindra Bank, said in a tweet that the Evergrande crisis was reminiscent of the IL&FS issue that in India, noting that the government had moved “swiftly" to calm financial markets.
Evergrande seems like China’s Lehman moment. Reminds us of IL&FS. Indian Government acted swiftly. Provided calm to financial markets. The Government appointed board estimates 61% recovery at IL&FS. Evergrande bonds in China trading ~ 25 cents to a $.— Uday Kotak (@udaykotak) September 21, 2021
As news emerged of Evergrande’s troubles, the first stocks to take a hit were of metal businesses with reports of a drop in industrial metals and ore prices across the world. In India, the BSE Metal index was down 6.8 per cent on September 20, its lowest point in months.
Markets worldwide also registered drops with the S&P 500 sliding by 1.7 per cent, its biggest drop since May.
China is the world’s largest user of construction material and a decline in property activity in the country would have ramifications for the global steel and construction materials industry with experts saying a decline in steel and iron ore prices will hit the earnings of companies in this sector, including those based in India.