The Evergrande Crisis!
In today's article, we will speak about what’s happening with the real estate sector in China & look at some similarities to 2008 because of Evergrande, one of the biggest real estate developers in China with close ties to the Communist Party looking at a possible bankruptcy?
What is Evergrande?
Evergrande is a Fortune 500 enterprise & the biggest residential developer in China with yearly revenues amounting to $110Bn, employing 2 lakh directly & creating 3.8m jobs each year indirectly. It's current liability stands at 2% of China’s GDP. Evergrande Group has to repay about USD 305Bn to lenders and other investors which seems to be at risk because of the cash crunch.
Why did this happen?
For years, the Chinese government has been facilitating easy financing for real estate companies like Evergrande. This enabled cheap debt which led these companies buying land, all across the country, creating what we call artificial demand and thereby increase in land prices. The increase in land prices led to a boom in property prices.
Evergrande, one of the largest realtors in China, has been so indebted that the norms set forward by the Chinese government will stop them from taking any further debt. Many people are comparing this to the Lehmann crisis of 2008 - where the US investment bank fell like a pack of cards under its debt burden leading to a global financial crisis.
However, we should be mindful that the 2008 Lehmann crisis involved trading in exotic derivative instruments with global participants and leverage. Evergrande has plain vanilla debt in its books, most of which is owned by the Chinese banks, hence the spiral effect might not be seen throughout the globe. But a total collapse of the Evergrande group won't fare well for the Chinese economy.
Real estate prices might come crashing down as developers would try to get rid of properties to pay back loans. This will lead to erosion of wealth with household investments tied to real estate.
It can also lead to slow credit growth as banks would be more conscious of disbursements leading to slow domestic growth.
Lastly, in case the government bails out, Yuan might depreciate as well.
Evergrande has gone from boom to bust in a few years and is now fighting to stay alive. The company’s shares have collapsed and dealing with its $305Bn mountain of liabilities will take months if not years. Even though Chinese policy makers may be able to avoid a financial crisis, the Evergrande ordeal could still inflict lasting damage to credit conditions and the economy.
Until next time....