Global investors are watching with panic as one of China’s biggest real estate developers struggles to avoid defaulting on billions of dollars in debt, raising fears of potentially widespread shock waves for the financial system.
Chinese regulators have yet to say what they can do about Evergrande Group. Economists are hopeful if Evergrande and the lender cannot agree on how Beijing will handle its loans. But any official proposal is expected to include losses for banks and bondholders.
The government “does not want to see engineering as a bail out” but is likely to organize a debt restructuring to “mitigate systemic risk and minimize economic disruption”, said Tommy Wu of Oxford Economics in a report.
Why is China’s Evergrande causing concern in global markets over fears of debt default?
Evergrande is the biggest casualty ever since the ruling Communist Party’s effort to rein in rising debt levels Beijing sees as a potential threat to the economy.
Investors watch how a developer headquartered in the southern city of Shenzhen near Hong Kong handles interest payments on one of its bonds on Thursday.
A look at Evergrande and its concerns about its debt troubles:
What is Evergrande?
Evergrande Group, established in 1996, is one of China’s largest apartment, office tower and shopping mall builders and one of its largest private sector conglomerates.
The company says it has more than 200,000 employees and supports 3.8 million jobs in construction and other industries. Evergrande says it has 1,300 projects in 280 cities and assets of 2.3 trillion yuan ($350 billion).
Evergrande founder Xu Jian was China’s richest entrepreneur in 2017, with a net worth of $43 billion, according to the Hurun report, which follows China’s wealthy. They’ve whittled down the list due to the boom in Internet industries, but still ranked as China’s richest real estate developer last year. He also topped Hurun’s 2020 list of philanthropists, paying an estimated 2.8 billion yuan ($420 million).
Evergrande has branched out into electric vehicles, theme park development, health clinics, mineral water and other businesses.
What has been the impact so far?
Hong Kong-traded shares of Evergrande are down 85% since early 2021. Its bonds are trading at a similarly deep discount.
Xu built Evergrande on borrowed money, possibly far more than rivals in a debt-dependent industry. As of June 30, Evergrande reported 2 trillion yuan ($310 billion) of outstanding debt to bondholders, banks, construction contractors and other creditors.
Of that debt, 240 billion yuan ($37.3 billion) was within a year, 28.5% down from the end of 2020, but nearly triple Evergrande’s 86.8 billion yuan ($13.5 billion) in cash holdings, according to the company’s financial report. Was.
In early 2021, Evergrande estimated that its total annual trading volume would exceed 2 trillion yuan ($310 billion). It posted a profit of $1.4 billion in the first half, but said sales were weakening as news of a cash crunch stunned buyers.
Evergrande was caught by new limit regulators imposed on real estate-related lending as part of the Communist Party’s marathon campaign to reduce its dependence on debt.
Economists have been warning that China’s rising debt is a potential threat for more than a decade. The ruling party has prioritized mitigating such financial risks since 2018. But total corporate, government and household borrowing rose from 270% in 2018 to nearly 300% of economic output last year. This is unusually high for a middle-income country.
News reports indicated that Evergrande had borrowed everywhere, including requiring employees of its construction contractors to purchase their debt.
In 2017, state-owned China Citic Bank in Shenzhen agreed to lend 40 billion yuan ($6.2 billion) to the Evergrande project after its executives agreed to lend at least 3 million yuan ($6 billion) to the Evergrande project, according to business news magazine Caixin. 465,000) agreed to invest.
How does this fit into the party’s plans to rebuild the Chinese economy?
The Communist Party has cracked down on debt as it seeks to nurture self-sustaining economic growth based on domestic consumption rather than trade and debt-backed investment.
It allowed China’s first corporate loan default since the 1949 revolution in 2014 as part of efforts to force borrowers and lenders to be more disciplined. Until then, the government had intervened to weed out bankrupt borrowers to avoid scaring the financial markets. Beijing has gradually allowed more defaults, but not as big a debtor as Evergrande.
What about other real estate developers?
Other major developers such as Vanke Company, state-owned Poly Group and Wanda Group have not reported similar problems. But hundreds of smaller developers have shut down as regulators in 2017 began tightening controls on fundraising strategies such as selling apartments before construction could begin.
Chinese residential real estate is considered to be of little risk to the financial system, however, most apartments are paid for with cash, not a mortgage. This creates a wave of defaults like the United States did after the 2008 crisis and is not easy and easy for banks to manage.
“Given how bloated China’s property developers are, there could be a whole wave of defaults right around the corner,” Simon McAdams of Capital Economics said in a report, but Beijing has “a full-blown Chinese debt crisis.” There are resources to stop it. “For all its flaws, it has an advantage of having a tightly controlled financial system versus a more free-market system.”
Risk outside China?
Some commentators suggest that Evergrande may become China’s “Lehman moment”, referring to the failure of Wall Street bank Lehman Brothers, a precursor to the 2008 crisis. But economists say the risk of a broader financial market transition is low.
“A managed default or even messy collapse of Evergrande will not have a global impact beyond some market turbulence,” said McAdam of Capital Economics.
Evergrande has $18 billion in foreign currency bonds outstanding, but most of that is with Chinese banks and other institutions. Unlike Lehman, whose assets were financial instruments whose prices can swing wildly, Evergrande owns 1.4 trillion yuan ($215 billion) of land and partially completed projects with relatively stable prices.
Macquarie Group’s Larry Hu and Xinyu Jie said that while unlikely to completely default, China’s banking system has an annual profit of 1.9 trillion yuan and reserves of 5.4 trillion yuan against bad loans, “which could easily be harmed.” can absorb.” report good.
Investors are waiting to see what Chinese regulators can do, but analysts say they are focused on protecting home buyers by completing paid-for apartments in advance.
The government has poured money into other bankrupt Chinese companies, but economists say Beijing is determined to avoid doing the same with Evergrande.
In August, Huarong Asset Management Co., Ltd., the largest of a group of companies created to help resolve bad loans held by state banks, lost 102.9 billion yuan ($15.9) to the state’s capital. Capital was drained out by injection from owned companies. Arab) last year.
In a letter to employees Tuesday, Xu expressed confidence that the company would survive.
“Evergrande will certainly get out of the darkest moment as soon as possible,” Xu said in the letter, marking the traditional Mid-Autumn Festival.
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