The Evergrande Dilemma:

Fears of a new credit crisis similar to the one global economies experienced in 2008 have grown recently, amid divergent views on global market collapse following the worsening crisis of China’s Evergrande (one of the world’s largest real estate companies). The Evergrande Group has not been able to pay the $83 million interest accrual on a March 2022 dollar-denominated bond. Associated banks have not seen any flow of interest payments to the accounts of the company’s creditors as pertains to the real estate giant’s bonds. The 30-day grace period on $150 million bond payments has also expired, driving the company towards officially defaulting on the payment.

Features of the Crisis

In mid-September 2021, Evergrande announced that it was at risk of defaulting on its debts amid a decline in real estate sales. It also indicated that two of its companies had failed to pay $150 million in obligations on time. Evergrande’s stock price immediately collapsed to unprecedented levels, and a state of fear prevails among their contracting consumers over more than 1.6 million housing units that the company is supposed to develop. The features of the crisis are:

1. Increasing Evergrande debt: The Evergrande Group is the second-largest real estate developer in China, and the second-largest in the world in terms of revenue. The company also offers 14.5% of its stock on the Hong Kong market. Its business was marked by accelerated activity and growth in revenue and projects, growing by 2018 to 6.5 times the share price at the start of its public offering in November 2009. 

The company’s sales pace and operating revenue started to decline in 2018, coinciding with increased debt expenses resulting from loans signed during the period of growth in activity, lured by large expansions, business volume, and demand for the company’s projects. The value of its debts reached $572 billion in loans from banks and other financial institutions. Of that, $240 billion is due in less than one year, and the debt burden has reached $300 billion (equivalent to about 2% of China’s GDP), although the value of Evergrande’s assets is $352 billion.

In 2018, the company defaulted on more than $4 billion in debts. Then came the fallout of the COVID-19 pandemic, which exacerbated the crisis. Evergrande gave discounts on its units and real estate of about 30% in 2020, in an effort to attract customers. This led to the company’s stock falling by 11% in mid-September 2021, bringing the total decline to about 80% since the beginning of the year.

2. Declining sales and profits: The Chinese company’s sales slowed significantly during 2019 and 2020, by 2% and 6% respectively, compared to 59% in 2016. Then profits fell by 29%, reaching $10.5 billion during the first half of this year, compared to the corresponding period of 2020.  

3. Credit rating downgraded: The three major credit rating agencies—Standard & Poors, Fitch, and Moody’s—downgraded their ratings of the company in September 2021 due to weak liquidity and the risk of default on debts. This contributed to high interest rates on Evergrande’s debt. Given that the loans are variable interest loans, alongside the company’s need for bank liquidity, interest and debt expenses have risen in a compound manner, putting pressure on revenues.

4. Large stakes in the company sold: In September 2021, Evergrande management acknowledged its financial difficulties, chiefly the lack of liquidity, and confirmed its intention to hire consultants to explore restructuring. In light of poor available liquidity, Evergrande had to negotiate with creditors to reschedule and settle the debt at the lowest possible cost. This past September 22, the company’s real estate division settled the interest payment due on 23 September 2021 for its yuan-denominated bonds after negotiating with creditors outside the clearing house. But it was unable to pay, and officially defaulted on $7.4 billion in bonds due in 2022, thus triggering a financial crisis in China.

That prompted a number of large investors in the company to pull out of their investments and sell stocks and major stakes in the company under heavy losses. These investors include Chinese Estates Holdings, which sold $108.9 million shares for $246.5 Hong Kong dollars ($31.7 million) in less than a month, amid expectations that it will give up the rest of its stake, despite a financial loss of about HK$9.5 billion in the event of a full exit. The Beijing government has tried to control the crisis by pumping $14 billion into the banking system to provide liquidity. Evergrande also mortgaged some of its property and equipment to secure repayment of a portion of the loans, which have an average interest rate of 9.02%, but the crisis is ongoing.

Mixed Repercussions

The main repercussions of the Evergrande crisis on the Chinese and global economy are:

1. Impact on the Chinese real estate sector: The Chinese real estate market currently includes a large number of small businesses in financial crisis. As a result, there are many unfinished construction projects that have demolished or detonated. The Chinese government detonated 15 unfinished residential buildings in Kunming city in August 2021, and other buildings that had remained incomplete for 20 years were demolished in Shanghai in April 2021.

The scope of the crisis is likely to extend to more Chinese real estate companies, including both major and small real estate developers. As companies have restricted access to bank financing, it is possible that more developers—especially those in a weak financial position—will face financial difficulties as well. Perhaps most notable of these is China Fortune Land Development. It is expected that the real estate companies’ crisis—if not dealt with—will increase the risk of investing in the real estate sector in the short and medium term. This sector’s growth rates will decline, with negative consequences for the Chinese economy.

2. Credit crisis in Chinese and foreign banks: In the event of Evergrande’s bankruptcy, many banks and financial institutions will be exposed to the company’s debts. About 170 Chinese banks and 120 foreign banks will be impacted – which will constitute a major shock to the banking sector. There is also the $160 billion in debt to companies that provide building materials to Evergrande, which in turn owns more than 1,300 housing projects in 280 Chinese cities, and more than 1.4 million unfinished housing units. This means they will be unable to sell them, thus exacerbating the banking crisis, as about 41% of the Chinese banking system’s assets are directly or indirectly tied to the real estate sector as of the end of 2020.

3. Slow Chinese economic growth: The crisis is likely to contribute to a slowdown in the performance of the Chinese economy in the short term, especially as the real estate sector contributes about a third of China’s GDP. Recently, the Fitch agency lowered its growth projections for the Chinese economy for 2021 and 2022 to 8.1% and 5.2%, respectively, down from 8.4% and 5.5%, in light of the weak Chinese real estate market.

4. Impact on the Australian economy: The Chinese giant’s current crisis is a red flag for Australia’s economy. China is Australia’s largest trading partner, with a trade exchange volume of about $233 billion in 2020. Among the economic sectors most impacted by the crisis were the stock market and the global metals market. Consequently, Australian exports were hurt. Australian exports of iron ore to China amounted to about $85 billion last year. The decline of the Chinese real estate market is contributing to decreased demand for iron and cement, leading to lower prices worldwide. The free fall of the stock markets also has the potential to drive economies into decline, as companies retreat from investment projects and put off hiring workers.

5. Negative impact on the Chinese labor market: The bankruptcy or insolvency of Evergrande will lead to layoffs. The company employs 200,000 people, is present in more than 280 cities, and indirectly creates more than 3.8 million Chinese jobs. Layoffs increase the Chinese unemployment rate and has a negative impact on individual income levels. Thus, the standard of living decreases and demand falls in general, which will place the Chinese economy at risk of recession.

6. Damage to some international companies: Evergrande has more than 1,300 projects in more than 280 cities in China, and was helped in implementing them by strategic cooperation with more than 860 companies around the world. Accordingly, it is probable that the Chinese company’s insolvency will impact the activity of these companies and their financial position.

It is estimated that about 10% of US manufacturing companies’ sales are likely to be exposed to the risks of the crisis, in addition to European raw material companies, such as Anglo American, Glencore, and European cement manufacturers. Despite the direct financial costs of the Evergrande crisis to foreign investments and companies, the upper limit of foreign exposure to the company’s debts is $18 billion in foreign exchange bonds. However, like China’s foreign bonds in general, a significant portion will be held by foreign entities that belong to Chinese companies. Consequently, the indirect costs to foreign investors will be limited, given the weak volume of cross-border investments with China. As investor fears of a sharp fall in global markets that could lead to financial market turmoil have risen, this is likely to delay plans to withdraw monetary stimulus in advanced economies, even if the impact is more severe on many emerging markets.

In conclusion, it is unlikely that Chinese real estate giant Evergrande’s debt will trigger a global financial crisis like the one in 2008. The current global banking sector is stronger and more robust, possessing huge financial liquidity and significant credit solvency that helps raise its ability to carry on, compared with its situation in 2008. Thus, the current crisis fundamentally differs from the 2008 crisis in terms of structure, magnitude, and impact on different sectors, whether the global real estate sector or the banking sector. The size of Evergrande’s debt also does not exceed $300 billion, while the size of the Chinese economy is more than $16 trillion, with a GDP of more than $14 trillion. The government can easily contain the crisis.

Therefore, it can be said that the Evergrande crisis is a difficult financial test for the Chinese government, but it will not allow its financial system to be shaken. The Chinese government still has a closed capital account leaving ample room for local debt restructuring, thus avoiding the worst-case scenario of the company’s liquidation or bankruptcy. At the same time, it will limit the company’s crisis from spreading to international markets. For this reason, the hypothesis that the Evergrande crisis is comparable to the collapse of Lehman Brothers and the 2008 crisis is of limited validity.