It was one of the most prolific property developers in China. In 2018, it became the most valuable real estate company in the world, and has been part of the Global 500. The China Evergrande Group still remains the second-largest real estate company in the country.
However, since media reports from August to September 2021 have emerged describing the piling debts of the company and the possibility that it would not be able to pay its upcoming dues, it has become the most indebted real estate company in the world.
Explaining and Understanding the Evergrande Debt Crisis
The Evergrande Debt Crisis has been described as the Chinese version of the Lehman Brothers Crisis, which was one of the prime catalysts to the collapse of the U.S. housing bubble, the Subprime Mortgage Crisis, and the 2007-2008 Financial Crisis.
But what exactly happened? What went wrong? For starters, the real estate company was founded in 1996, and it rapidly expanded during the housing boom in China from 2005 to 2009. It successfully bought lands and developed thousands of properties for market-rate and luxury residential markets in over 280 cities across the country.
However, sales began to slow down post-property boom. Evergrande increased its debt to diversify its business. These include entering the automotive, tourism, media and entertainment, finance, healthcare, music, and food production sectors and markets.
The company eventually accumulated more than USD 300 billion in liabilities. Over the last few weeks leading to 21 September 2021, it warned its investors of its cash flow problem, explaining further that it could default if it was unable to raise capital quickly. In a stock exchange filing, it also disclosed that it was having trouble selling some of its assets.
A possible collapse has been looming. Institutions that have exposures to Evergrande have grown uneasy. It is also worth mentioning that about two-thirds of its liabilities come from 1.7 million undeveloped properties pre-sold to individuals.
Observers and analysts have identified several factors behind the Evergrande Debt Crisis. Mattie Bekink, the China director of the Economist Intelligence Unit, explained that the company became too aggressive in its diversification strategy and other business pursuits, thus straying far from its core business while accumulating debt.
Analysts from Goldman Sachs also noted that the complexity of the organizational structure of the company and the absence of easily accessible and sufficient information have made it difficult to readily evaluate its assets and liabilities.
Then there are those who partly underpin the problem to the debt-related structural challenges in the Chinese economy. Xie Yu and Elaine Yu of The Wall Street Journal mentioned that the Chinese government began a clampdown campaign in 2020 to curb the debt levels of property developers and control the surging prices of homes and reduce residential borrowing.
Evergrande responded to this policy by selling some of its businesses and assets at a serious discount. Several transactions were successful. However, some have remained unsold. The company was not able to generate enough cash to settle its interest payments.
The liquidity problem of the company has become more apparent. Its shares have been plunging at the start of 2021. Unable to sell its assets and raise capital through the stock market, in addition to declining revenues due to the downward trend in the real estate market, the company end up in a debt crisis and on the brink of a possible collapse.
Immediate and Possible Impacts and Actions Related to the Debt Crisis
Reports about the Evergrande Debt Crisis have rattled governments and investors alike. The size of the company has made it too big to fail. In other words, if it collapses, it will send a ripple effect across the Chinese economy and the rest of the world.
The shares of the company have crashed more than 80 percent. 4 January 2021, it traded at HKD 14.1 or USD 1.8, and its price per share plummeted to HKD 2.6 or USD 0.3 by 16 September 2021. Rating companies Fitch and Moody’s downgraded its credit rating earlier in September 2021 due to its liquidity issues and a probable default.
In China, the Hang Seng Index suffered its worst decline in nearly two months as it dropped by 3.3 percent on 20 September 2021. Stock markets across the world, including in Hong Kong and New York, were also hit by a major sell-off on the same date.
The cryptocurrency market also experienced a setback as a response to the sudden drops in the U.S. stock markets, including S&P, Nasdaq, and Dow Jones Index. For example, Bitcoin dropped by 5.7 percent while Ethereum and Dogecoin declined by 4.4 percent and 6 percent, respectively, within the 24-hour period of 20 September 2021.
Note that the aforementioned are some of the notable immediate impacts of the Evergrande Debt Crisis. Analysts have noted more lasting impacts on the Chinese economy and the rest of the world, especially if the company collapsed.
Evergrande directly employs about 200,000 people and it is also responsible for indirectly generating and sustaining 3.8 million jobs each year through its transactions and dealings with other businesses from different industries and sectors.
A collapse will endanger not only the jobs of its direct employees but also the companies that do business with Evergrande-related projects and businesses. Remember that the company has diversified beyond the residential property market. Examples include construction companies, design firms, and material suppliers, among others.
Individuals who bought pre-sold and undeveloped property projects will also be affected negatively. Specifically, they are at risk of losing what they have paid if the company collapsed and failed to deliver completed properties or refund payments made in advance.
There is also the potential impact on the Chinese financial system. The company owes money to around 171 domestic banks and 121 other financial institutions. Failure to settle its interest payments or defaulting to its entire liabilities would reduce the lending capabilities of these institutions, thus resulting in a credit crunch and reduced public access to loans.
However, some measures have been proposed to contain, reverse, and resolve the Evergrande Debt Crisis. Because the company is too big to fail, its systematic importance could encourage a bailout from the Chinese government.
China has advised financial institutions to save the company from the brink of collapse through capital infusion. Other analysts have suggested a debt-to-equity scheme in which its outstanding debts to its creditors would be converted to equity or shares, thus avoiding defaults and allowing it to reallocate current and future budget from debt payments. Photo credit: MNXANL/Adapted/CC 4.0
FURTHER READINGS AND REFERENCES
- The Economist. 2012. “China’s Dodgy-Debt Double Act.” The Agonies of Huarong and Evergrande. Available online
- Yu, X. and Yu, E. 2021. “How Beijing’s Debt Clampdown Shook the Foundation of a Real Estate Colossus.” The Wall Street Journal. Available online