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Evergrande- Perhaps Not To Be Ever Grand?

Updated: Jun 24, 2022

The Evergrande Group, China’s leading real estate developer, has found itself with debt totalling over $300 billion, while it has over 800 unfinished housing projects and unhappy shareholders. After missing its most recent deadline on September 29th of a $46 million interest payment the chances of the property giant meeting its next deadline on 18th October are slim. Such a default would not only throw the Asian financial market, but also the Chinese government into turmoil.

To understand how Evergrande has spiralled so far into debt, we need to look back to 1996 when Xu Jiayin, once China’s richest man, founded Evergrande at a time of mass urbanisation in China, helping spark a boom in property prices. In the early 2000s, China began to privatise state-owned enterprises, allowing wealthy entrepreneurs to join the Communist Party of China. Consequently, Xu increased his proximity to power as he became a member of China’s ‘People’s Political Consultative Conference’ – an integral part of the Government that advises on foreign relations. With such a strong political-economic backing, it gave investors the assurance to loan tens of billions to Evergrande. Evergrande’s business model works by selling apartments before they are completed to ensure a continuous flow of cash. The company has since become increasingly reliant on loans from state banks, whilst the nexus between the Chinese government and Evergrande has meant that the state has become more dependent on the property giant’s ongoing success. As a result, Evergrande’s downfall, and the government’s response, will not only significantly impact China, but will demonstrate whether the Chinese government is moving away from solely prioritising economic advancement.

As Evergrande accrued more and more debt, the Chinese government became increasingly concerned about their borrowing, as well as the trend it set within the market. Their borrowing rates were so high that the Chinese government feared it could jeopardise the sustainability of the entire retail estate market, a major part of the economy. Alongside this, the Government has since begun to feel that their investments could be channelled into more productive industries; Evergrande’s strategy of aggressively buying up land to drive up house prices has made property unaffordable for millions. As a result, the Chinese government decided it had to interfere, regardless of the potential consequences on the property sector.

This interference came in the form of the ‘three red lines’ for home developers, introduced in August 2020. This laid out a strategy to limit property developers’ debt according to three standards- the ratio of net debt to equity, liabilities to assets and cash to short term borrowings. This means the more a firm owe, the less they can borrow. Unsurprisingly, this came as a significant blow for Evergrande. The world’s most indebted developer went on to breach all three of the ‘red lines’ and was subsequently banned by regulators from any further borrowing.

To overcome this, Evergrande pre-sold more than 1.4 million unfinished apartments, requesting deposits of over a third of the property price. However, when this failed to generate enough income, they turned on their own employees, pressuring them to loan the company money under the guise of a ‘high-interest investment scheme’. Those who failed to participate risked losing their bonuses. Fast forward to September 2021, the company stopped paying back the employees who opted into the scheme, meaning they now face a barrage from disgruntled employees, shareholders, and homebuyers, all of which are demanding their money back. This panic has seen Evergrande’s stock value steadily fall from $4 per share 12 months ago to just $0.30. As well as this, it has now missed two vital interest payments in the last month, totalling $131 million- just a small fraction of its total debt.

If Evergrande cannot pay its debt by the end of the 30-day grace period and instead defaults, it could have disastrous consequences that ripple through not only China but the rest of the globe. The major worry for the Chinese government is the potential ricochet effect on its economic growth - 41% of China’s domestic banking assets were associated with the property sector by the end of 2020 and Evergrande still owes money to 170 domestic and 121 international firms. This crisis is likely to stain the Chinese economy as a far less attractive investment opportunity. Meanwhile, the 1.4 million pre-sold apartments are unlikely to be completed, leaving home buyers and unpaid suppliers in the dust. Furthermore, many of these companies are themselves on the verge of bankruptcy, with nothing but Evergrande’s empty promises in their coffers.

Outside of China, there have been several comparisons to the fall of Lehman Brothers and its contribution to the 2008 Global Financial Crisis. It has, therefore, called into question whether the collapse of Evergrande could have a similar effect if the Chinese government chooses not to bail it out. As the global economy tries to recover from the economic damage caused by the COVID-19 pandemic, further pressure has been directed at the Chinese government to act. Although most analysts suggest that the debt is not far reaching enough to trigger a collapse of the global economy, it may affect developing economies such as India, resulting from the fact that China is a major importer of Indian metals and chemical products.

This leaves Beijing with a dilemma: does it simply let Evergrande collapse and try to minimalize the consequences, or does it intervene? If so, what kind of message does this convey? This is a question upon which economic and political analysts seem to be divided. Economists suggest that the government will be forced to act, unwilling to let the property industry (accounting for 25% of its GDP) go bust. On the other hand, most political experts feel that the Government’s priorities are no longer simply growth oriented. The financial losses that have come from the government’s crackdowns on private tutoring and major technologies companies suggest that they care more for working towards the goal of “common prosperity” than for continuing rapid economic growth. If the same shift in attitude is applied to Evergrande it is unlikely the government will involve itself, thereby setting an example and showing itself to be hardline on reigning in debt. We are, however, unlikely to see any final decisions until later this year, when the rest of Evergrande’s repayment deadlines expire.

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