Evergrande – Crisis Knocking at Chinese DoorsOctober 14, 2021
While the old imperialist mouthpiece, The Economist, was in the process of announcing that, by its reckoning, China had replaced US as the most dominating economy in the world, Evergrande Group, the 2nd largest real estate developer of China was in the process of informing the Stock Exchange that it had run out of cash and couldn’t meet its scheduled debt repayment obligations, i.e., it was defaulting on its interest and principal repayments unless banks and other lenders agree to restructure the repayments, that is, give a breather to it by postponing scheduled repayments.
The group’s shares have plunged nearly 80 per cent this year and it has already faced multiple downgrades by ratings agencies. Evergrande Group is the world’s most indebted real estate developer with dues worth $305 billion, including bank loans, bonds, short-term borrowings, and supplier credits among others. The amount is equivalent to 2 per cent of China’s GDP and probably one of the biggest debt piles in the world. It was once China’s top-selling property developer but tightening of lending rules by the country has made existence difficult for the debt-laden company. Evergrande’s operating income has plunged over 75 per cent since 2018.
Like all major financial crises, Evergrande Group’s financial woes have not just popped up in a day but due to years of aggressive borrowing. The debt-fuelled growth has served the company well, helping it expand its business empire — to the extent that it owns China’s most popular football club, Guangzhou FC. Over the years, it has emerged as one of China’s top real estate developers with more than 1,300 projects spread across 280 cities. The group has also expanded to businesses like wealth management, electric cars, theme parks, bottled water, groceries and dairy products. The company enjoyed rapid growth during the mid-2000s and the post-2009 global financial crisis, riding on the wave of surging property prices and high demand. However, property sales have slowed down significantly in China — a huge blow for the company that had a four per cent share of China’s total property sales.
But the primary reason why the company has landed in trouble is due to high levels of debt that accumulated as a result of the company’s rapid business expansion. The final blow to Evergrande came after the Chinese government’s crackdown on lending to property developers as part of the country’s larger efforts to tackle rising bad loans. The Chinese administration has effectively launched investigations into financial institutions and shadow lenders that were willing to refinance short-term debt of real estate developers. Credit limits were also imposed on property developers, making new borrowing difficult.
This crippled real estate developers like Evergrande that often used this mechanism to fund and generate revenue from new projects. As a result, the company is sitting on top of nearly 800 unfinished residential projects along with a swarm of unpaid suppliers and lakhs of homebuyers who are demanding action against the company. To reduce its debt, Evergrande ultimately tried selling off properties at very low margins to quickly raise cash. However, its efforts have been inadequate as interest on its existing debts have spiked sharply.
Without a bailout plan by the Chinese government, Evergrande is likely to default on its existing repayments as its business prospects remain weak. There is no scope of new lending and most of its money is stuck in unfinished properties and it will be difficult to monetise them at a short notice. However, most analysts firmly believe that Chinese authorities will not let the situation spiral out into a global crisis. While the Chinese government has remained mostly quiet on the Evergrande crisis, many ratings agencies and financial institutions believe that steps may be taken to prevent a full-blown financial crisis. It is expected that the Chinese government will help Evergrande get some capital at the least. However, the group may be forced to sell some of its stakes to a third party, such as a state-owned enterprise. The spin-off of non-core businesses, for example, those that are not residential real estate type businesses, will probably be done first. After that could come sales of stakes that are at the core of Evergrande’s business.
There is no way that Chinese authorities will allow the crisis to blow up uncontrollably since China’s financial system will be hurt severely as approximately 41 per cent of the banking system’s assets were either directly or indirectly associated with the property sector as of end-2020. Therefore, most analysts do not believe that the Evergrande crisis will become China’s ‘Lehman moment’ as policymakers will likely prevent systematic risk and buy time for resolving debt and pushing forward towards marginal easing. It can be considered more like the collapse of IL&FS in India, which though smaller had also ended up in crisis due to the fast debt-fuelled business expansion and had to be bailed out by government and its assets sold at discounted prices for part recovery in cash.
However, the important thing to understand is that in last 2 decades Chinese economy has grown on breakneck pace based on huge construction activity driven by humongous amounts of capital liquidity provided by its financial system as well as foreign capital investments. The money has been used to build, one, immense transport infrastructure – highways, highspeed railways, waterways, airports, etc – linking the industrialised coastal areas with the vast hinterland; and two, forced paced urbanisation creating number of huge cities and new hubs like Wuhan, where immense quantity of real estate, both commercial and residential has been built, using bank and shadow banking credit and also sold on the back of bank loans, so much that real estate now forms 29% of Chinese GDP. However, this has driven the real estate prices sky high, among the highest in the world, and sales are becoming increasingly difficult. That is resulting in massively expanded and debt laden developers ending up in crisis as with their cash flows drying up, they find themselves unable to complete projects. So much is the oversupply that 15 Tower Blocks had to be demolished in Kunming, the capital of Yunnan, last month after sitting eight years unfinished.
China has been able to overcome earlier financial crises, for example, 2008 Global Financial Crisis, through huge cash stimulus provided by People’s Bank of China (PBOC). But it has made China among the most debt laden economies in the world. Moreover, it has created huge number of billionaires second only to USA. Similar to the turn of 20th Century US, it is being called the Chinese Gilded Age where number of immensely wealthy Robber Barons have emerged on the back of this politically directed capital accumulation.
The inequality between these Robber Barons on the one hand and overworked but low paid workers has been creating new grievances and political problems for the ruling ‘Communist’ Party. It has tried to address this under the leadership of Xi Jinping by some welfare and poverty reduction measures on the one side, and, on the other, regulatory crack down on some of these Robber Barons like the tech giants Jack and Pony Ma of Alibaba and Tencent, online lenders and recently on the private schools and ed-tech sector firms. This is again on the same lines as US which tried to crackdown on US Robber Barons by repeated attempts to break the monopolies and Trusts in 20th Century, for example, breaking up of Rockefeller’s Standard Oil, AT&T, etc and passing of Glass-Steagall Act of 1933 under which banks like JP Morgan were broken up by forcefully separating Commercial and Investment banking. Similar has been the constraints put on real estate developers as already described above. But it is creating its own problems, as demonstrated by Evergrande.
However, the reality is that the laws of capitalist development cannot be ignored at whim and keep on working inexorably. All attempts at breaking monopolies could not succeed in doing so in US and will neither succeed in China. Similarly, US and European capitalist countries could not prevent financial crises by measures like monetary easing and lower interest rates, and so will not China. Capitalist development is bound to create economic and financial crises and bring about all sorts of liquidity and credit crunches, business collapses, closures, bankruptcies, liquidations, etc followed by layoffs, retrenchments, and unemployment in its wake. Rest all is purely wishful thinking.