The China Evergrande debt crisis is shaking global markets. Here’s why.

The China Evergrande debt crisis is shaking global markets.  Here’s why.

Property developer China Evergrande Group has hundreds of billions of dollars in debt it cannot repay, which has rattled global financial markets this week on the specter of default. The brewing crisis has implications that extend far beyond the nation’s massive real estate sector. Here’s what you need to know.

Evergrande is a giant development company based in Shenzhen, southeast China, which rose to prominence in the construction of houses and apartment buildings just as the country was beginning to introduce property ownership. private. It fed on a voracious appetite for expansion and a steady flow of cash – thanks to consumer payments and prolific borrowing.

Founded in 1996, it has more than 1,300 development projects in 280 cities and has expanded into other major industries – it has an electric car manufacturer, a mining group, a football team and even a theme park – as the business matured.

Its founder, the very wealthy Hui Ka Yan, proclaimed in a speech to employees in 2017: “Development is the absolute principle”, echoing a famous statement by the late Chinese leader and revolutionary Deng Xiaoping. The saying anchored a philosophy of unmitigated economic growth fueled largely by the booming real estate sector.

Evergande is “over-indebted”, a fancy way of saying that she is too indebted. How much? $300 billion. The company has pre-sold 1.4 million apartments worth more than $200 billion that it has not finished building. She started paying her bills by offloading unfinished projects to contractors, such as construction companies or painters.

For a while, Evergrande’s debt wasn’t a big deal for Chinese regulators, said Bill Bishop, who writes the Sinocism newsletter. And then it was. Chinese President Xi Jinping unveiled in 2018 “three tough battles” for the country’s regulatory state: poverty, pollution and financial risk. Then, in 2020, regulators imposed “three red lines” on developers and their borrowing habits. The more over-indebted a developer was, the less regulators would allow him to borrow.

Evergrande crossed all three red lines, so regulators placed a hard cap on its debt – the main way the company created cash.

“The real trigger was these rules that came into effect, these three red lines, which said, ‘This time we’re serious,'” Bishop said. “These real estate companies can’t go into debt anymore, and if you can’t go into debt anymore, then the game is over. It’s like musical chairs.”

As the government loosened controls on the economy in the early 1990s and created an opening for capitalist principles, land ownership quickly took hold. Land has become an important collateral as individuals, businesses and financial institutions have had leeway in the market, Bishop said. As China’s middle class grew and homeownership rates rose, ever-increasing land values ​​underpinned much of the new economic growth.

This is where Evergrande came in; he soon purchased large tracts of land from local governments, who were eager to generate revenue to fund other elements of Deng’s massive development philosophy. To build on this land, Evergrande borrowed heavily. She could justify this loan because the value of her property kept going up and she was buying more and more land.

Meanwhile, these rising real estate values ​​seemed to be good for Chinese home buyers, as they almost constantly saw the value of their homes increase, fueling the continued growth of the consumerist middle class.

In reality, experts say, the system has just created a bubble.

To be brief: a lot.

Nearly a million Chinese home buyers have bought apartments in Evergrande that the company apparently can no longer afford to complete. These apartments are likely to be completed, experts say, but it could take time. Regulators may have to help sell these projects to other developers.

The Evergrande crisis pierces the veil of China’s real estate sector and artificially valued land and development projects. Experts say it could drive down the value of existing homes, which could dampen Chinese consumer spending – a consequence that could ripple around the world. Chinese owners treat their real estate like American owners do: it’s their biggest investment, and as it appreciates, their long-term economic fortunes improve. If its value goes down, Bishop said, “People will feel poor. There is a chance that this could initiate a prolonged downturn. »

Evergrande’s downfall could also be a blow to other Chinese developers. It could show that the government in Beijing is willing to drop massive companies if they take too much of a risk, potentially persuading Evergrande’s contemporaries to offload their debts. Experts are monitoring the government’s response to see what tone regulators have set. But it might take a few days. Much of China’s government and financial apparatus is shut down until September 22 for the Mid-Autumn Festival, one of the most important holidays on the Chinese calendar.

The first real test for the company will come almost as soon as the country reopens. Evergrande is due to make an $83 million interest payment on Thursday, and there are serious doubts about whether it has the cash to avoid a default.

Global markets plunged Monday on Evergrande’s situation, with the Dow Jones Industrial Average plunging as much as 971 points before paring losses to 614 points, a 1.8% drop on the day. The Hang Seng index in Hong Kong slipped 3.3%. Meanwhile, gold, a traditional haven for investors, jumped almost 0.8%. All of this action is a good reflection of the nervousness that traders are feeling.

Evergrande has its hands in so many other industries in China – wealth management, hospitality, media, natural resources – that some experts worry about “contagion” or a ripple effect. In other words, if a major economic pillar collapses, will it spread to other markets or regions?

Another concern relates to credit markets. Evergrande has borrowed so much, and so many lenders are at risk of being burned, would its potential default have a ripple effect for other borrowers? On both of these issues, say the experts, it is still too early to tell.

But troubling signs are already emerging: remember that hundreds of millions of Chinese homeowners could see their property values ​​plummet, meaning there’s a good chance they’ll rein in spending. Global consumer markets – on everything from clothes to electronics to food – depend on the prolific purchasing power of China’s middle class. If China is about to spend far less on consumer goods, there will be economic ramifications around the world.

Evergrande had a taste for expansion beyond its developments. He owns an electric car manufacturer, a mining company, even a theme park and a football team. Experts say many of these companies were born out of the voracious corporate appetite for land: if you own a car company, you need a factory, and you need land for that factory. . If this land increases in value, you can borrow to finance other projects.

In a rush to offload its debts, Evergrande is reportedly exploring sales of these assets, but buyers are hard to find. Experts say many could worry about the funding of any deal, or whether regulators would get involved to seize assets to pay off creditors.

Robert P. Matthews