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The Evergrande Crisis: China’s Lehman Moment?

Hey Readers! Recently Evergrande, one of the worlds biggest real Estate Group was near about to collapse and so today I will be explaining the main reason behind it, how does it affect global markets and most importantly India. Click the button down at the end of the post to listen to the article!

Synopsis

China’s massive and opaque banking system has long been a threat to the country’s economy and the international community. The woes of Evergrande, a property developer with massive debts, serve as a stark reminder of how difficult it is to manage risks. The government is attempting to inflict an orderly default on some of its creditors, but it risks spreading the problem. The stock and bond markets around the world are keeping a careful eye on China Evergrande Group, a Chinese property developer on the verge of defaulting on part of its loans. If it is not resolved, it might become Asia’s greatest corporate debt default, shattering investor confidence around the world. Beijing appears hesitant to bail out the company, but it is taking steps to mitigate the consequences.

What’s Evergrande?

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In 1996, the company began selling bottled water before moving on to pig rearing. Evergrande, situated in Guangzhou, now owns China’s premier professional soccer team (Guangzhou Football Club). The real-estate developer became the face of China’s real-estate boom. The post-pandemic economic boom of China was fuelled by a surge in property prices. Evergrande, too, expanded to over 250 cities but accumulated massive debt. Evergrande Real Estate now owns over 1,300 projects in over 280 cities around China. The Evergrande Group has expanded to include far more than just real estate development. Its activities include wealth management, electric car production, and food and beverage manufacturing. It even owns Guangzhou FC, one of the country’s most popular football clubs. Mr Hui was once Asia’s richest man and, despite his fortunes plummeting in recent months, Forbes estimates that he has a personal fortune of more than $10 billion (£7.3 billion). Evergrande is the world’s most indebted real estate corporation, with approximately $300 billion in liabilities. In comparison, Russia’s state debt was $257 billion in 2020. If the corporation goes bankrupt, it will have a significant influence on China’s economy. Because China is a key commercial partner for almost every country on the planet, economic issues in the country might have far-reaching consequences.

What is the trouble at Evergrande?

Evergrande borrowed more than $300 billion to expand quickly and become one of China’s largest enterprises. Beijing enacted new laws last year to regulate the amount due by large real estate developers. Evergrande was forced to offer its properties at deep discounts as a result of the new rules, in order to ensure that money was coming in to keep the company afloat. It is currently struggling to make interest payments on its loans. Evergrande’s stock has dropped by nearly 80% this year as a result of the uncertainty. Global credit rating agencies have also downgraded its debts. The Evergrande Group employs approximately 200,000 people and is China’s second-largest real estate corporation in terms of total sales. Its main business is to purchase vast tracts of land, convert them into residences, restaurants, and other structures, and then sell them to prospective customers. To support its operations, the corporation takes on enormous sums of debt from banks and investors, as well as short-term loans from suppliers and property buyers.

It has over $300 billion in total obligations and will have to pay roughly $37 billion in interest and maturing debt over the next year. Given the company’s poor financial state, rating agencies such as Fitch and S&P have downgraded the company’s bonds, which have traded considerably below 50 cents on the dollar. In addition, the company has received the money in advance from nearly 1.5 million homebuyers, promising to deliver developed properties to them in the future, and many suppliers have yet to be paid. The company’s wealth management staff has collected more than $6 billion from its own employees in the hopes of generating substantial returns. It has defaulted on these items and offered to give away parking spaces and another real estate in exchange for the loans, which has sparked public outrage.

Why is the company in trouble?

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The Chinese government’s new guidelines for property developers, according to observers, are the most urgent cause of the current problem. The Chinese government issued laws (commonly known as the “three red lines”) in August 2020, indicating how much a property developer can borrow based on its financial situation as determined by three debt criteria. Evergrande is effectively barred from taking on any further debt under the new restrictions. Evergrande’s business suffered a significant setback as a result of this, as the company relied heavily on borrowing to operate. As a result, the company was compelled to sell its land and other assets at a loss in order to pay its debt obligations. Evergrande’s insolvency is said to have resulted from this asset fire sale. Some perceive the Chinese government’s new measures as an attempt to burst the country’s property bubble and bring the economy to a “soft landing.” To construct new properties, Chinese authorities have always encouraged firms to take on massive sums of debt through the tightly state-controlled financial system. This resulted in indiscriminate property development, with the property industry accounting for about a third of China’s GDP. In China’s “ghost cities,” millions of houses have been spotted with no interest from purchasers. Chinese authorities have also unwittingly aided the property bubble by bailing out problematic developers over the years.

Evergrande officials requested financial aid from the Chinese government in a letter published by Bloomberg last year, revealing their inability to pay their loan commitments to banks. According to reports, China’s authorities now wish to focus the country’s resources on other industries, such as technology and have so chosen to end their support for property developers. It’s worth noting that the Chinese government has recently allowed several property-related businesses to fail rather than bailing them out. Other observers, on the other hand, feel that the current problem has been building for a long time.

They claim that the business model of the corporation has been unsustainable for a long time. In 2012, Citron Research’s Andrew Left claimed that Evergrande was bankrupt and that the business was using aggressive accounting techniques to hide its problems. It was claimed that the firm kept properties it couldn’t sell as inventory on its financial sheet, avoiding the need to register losses. The company was also accused of conducting a ponzi scam since it relied on a continual input of cash to support a fundamentally unsustainable economic model. Surprisingly, Evergrande has regularly reported high earnings and a healthy financial sheet with ample liquid assets throughout the years.

What is the ‘Lehman Moment’ and why is the Evergrande crisis is being referred to as one?

The subprime mortgage crisis came to a head-on on September 1

5, 2008, when Lehman Brothers filed for bankruptcy. The Federal Reserve called six banks to discuss funding for the financial services firm’s restructuring after it was warned of a possible rating downgrading owing to its significant position in subprime mortgages. These talks fell through, and Lehman filed a Chapter 11 case, including more than US$600 billion in assets, which is still the biggest bankruptcy filing in US history.

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The bankruptcy caused the Dow Jones Industrial Average to plummet 4.5 percent in one day, the biggest decrease since the September 11, 2001 attacks. It indicated that the government’s ability to manage the crisis had reached a breaking point, causing widespread financial panic. Mass withdrawals from money market mutual funds, a crucial source of credit, were made to prevent losses, and the interbank lending market tightened, putting banks at risk of collapse. To quell the fear, the government and the Federal Reserve System took a number of emergency steps.

“The prospect of an Evergrande bankruptcy looks to be driving to concerns of China’s very own Lehman [Brothers] moment, with a large spillover throughout the region,” CMC Markets’ Michael Hewson said. Investors are also concerned that the US Federal Reserve will reaffirm plans to reduce assistance for the US economy this year during its meeting on Tuesday and Wednesday. Global stock markets have risen as economies have reopened and central banks have pumped billions of dollars into the economy to help it expand. However, if assistance is withdrawn at a time when the Delta type of coronavirus continues to stymie healing, there are fears of deterioration. Morgan Stanley strategists predict a 10% drop in the S&P 500 index as the Federal Reserve begins to remove its support. They went on to say that indicators of a stalled recovery may push the drop to 20%.

However, the Evergrande crisis might not be the Lehman Moment because of the following reasons:

  • Comparisons have been made between China Evergrande’s capacity to pay interest on its US dollar-denominated debts and the fall of Lehman Brothers in 2008 and the following global crisis.
  • When it comes to the size of the effect, commentators point out that China’s Evergrande owns land and Lehman Brothers has financial assets.
  • Chief Economist Gita Gopinath of the International Monetary Fund told Reuters this week that the IMF believes “China has the tools and the policy room to avoid this from developing into a structural crisis.”

How could the Evergrande Collapse affect China?

A major slowdown in property building over the next several years already looks imminent and would become considerably more so if Evergrande failed or went bankrupt. A long-term slowdown in property building, which accounts for roughly a fifth to a quarter of China’s economy, would result in a major drop in GDP growth, commodity demand, and possibly disinflationary consequences internationally, according to most estimates.

Will China Bail Out Evergrande and Avert a Housing Crisis?
Foreignpolicy.com

Markets are concerned about the impact of China’s property market turmoil on other nations. Foreign investors that have direct exposure to Evergrande or firms that are financially related to Evergrande, on the one hand, may suffer losses. Any slowdown in the Chinese economy as the nation attempts to rebalance its economy away from the property industry, on the other hand, would have an impact on the global supply chain. Metal equities in India, for example, have experienced a significant fall, which has been ascribed to concerns about a drop in Chinese demand. According to some observers, Chinese growth might fall to as low as 1-2 percent as the government rebalances its economy.

Banks and other lenders may be obliged to lend less if Evergrande fails. This might result in a credit crisis, in which businesses are unable to borrow money at reasonable rates. A credit crisis would be disastrous for the world’s second-biggest economy, as businesses that are unable to borrow find it impossible to expand and, in some circumstances, cease to exist. This may frighten international investors, who may perceive China as a less appealing location to invest in.

In the case of a collapse, the Chinese economy and financial system will be severely harmed, with a cascade effect affecting a number of other domestic industries. It will also have an influence on the global economy, particularly financial institutions and enterprises involved in real estate and housing, both directly and indirectly. According to CITI experts, China’s financial system would be badly harmed since, as of end-2020, roughly 41% of the banking system’s assets were either directly or indirectly linked to the property industry.

Analysts do not anticipate, however, that the Evergrande crisis will become China’s “Lehman moment,” as officials are more likely to avoid systemic risk and gain time for debt resolution and marginal easing. Home sales by value may have dropped 20% in August and September from a year ago, the largest decline since the coronavirus broke out early last year, according to data.

How has Evergrande Collapse affected the global markets?

China’s retaliation has been fierce. Evergrande has pledged to develop between 1.3 million and 1.6 million houses, according to various estimates, and sought loans from workers earlier this year, according to The New York Times, which it now appears unlikely to repay. Protests have erupted in front of Evergrande offices around China, as well as at its Shenzen headquarters. Those who demonstrated included employees, suppliers, and consumers who had paid for homes that have yet to be completed. World markets have braced themselves, even though the business has not yet formally defaulted. Many markets, including the S& P 500, the Nasdaq, Japan’s Nikkei 225, and Australia’s ASX, have fallen in the last 24 hours as a result of possible Evergrande problems. Cryptocurrency, too, has taken a blow.

Picture Source: indianexpress.com

Evergrande’s difficulties have corresponded with a drop in stock market interest: Between September 2 and September 20, the S&P 500 index dropped 5.2 percent. Evergrande isn’t the only source of anxiety, either. Recent economic indices, for example, have been trending sideways. Employers hired only 235,000 people in August, far less than market estimates. Consumer confidence has slipped to a six-month low as retail sales have fluctuated. Inflation continues to rise, and many expect the Federal Reserve will declare soon that it will stop buying bonds in November. While not as essential as rising interest rates, this so-called tapering indicates that the Fed is backing away from its emergency policy of putting in a lot of cheap money to help the economy recover from the Covid debacle. Then there’s Washington, D.C.

In addition to debating a contentious $3.5 trillion social programme package and a $1 trillion infrastructure plan, Congress will soon need to lift the debt ceiling to avoid the US Treasury defaulting on its debts. Republicans are refusing to cooperate now that Democrats have complete control of the legislative and executive parts of the government. If the economy slows and a new stimulus is not provided, one Morgan Stanley analyst predicts a 20% decline in stock prices. Much of the pessimism stems from fear of what might happen. These shocks in the foreign financial markets, on the other hand, would only be brief. Most other analysts have downplayed the comparison, claiming that even if the developer went bankrupt, it would have a minor worldwide influence.

How does it affect India?

In the previous five trading sessions, stocks of numerous leading Indian steel, mining, and chemical companies, including some of the index’s best-performing equities like Tata Steel, Jindal Steel, SAIL, JSW Steel, Tata Chemicals, NMDC, and DCW, have fallen by 10-15 percent. All of these businesses would have had receivables from the Chinese real estate corporation or would have been related to it. If Evergrande fails, this might be jeopardised. If this issue is not resolved quickly and the contagion spreads, commodity-exporting companies will continue to suffer.

Is the government going to help?

No one knows for sure yet, but there are some indications that the state will not save Evergrande. Aware of the amount of debt that real-estate companies were accumulating, China last year devised the “three red lines,” a system that requires property developers to maintain a liability-to-asset ratio of less than 70%, a net gearing ratio of less than 100%, and a cash-to-short-term debt ratio of at least one since last August. Companies like Evergrande would be prohibited from borrowing more money if they over these lines. The message to real estate developers was clear: it was up to them to clean up their act.

There are suggestions, though, that China’s regulators will offer Evergrande some leeway. Rather of purchasing its debts, regulators have authorised Evergrande’s proposal to restructure its loans, according to Bloomberg. This would entail extending payment dates.

This information is correct and factual to the best of the author’s knowledge, but it is not intended to replace formal, customized advice from a competent professional. This content is not plagiarized, and it is not intended to offend anyone’s feelings.

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