Why the Chinese economy is threatened by the debt problems of a real estate giant

Every now and then a business becomes so big and messy that governments fear what would happen to the economy as a whole if it failed. In China, Evergrande, a sprawling real estate developer, is that company.

Evergrande has the distinction of being the most indebted real estate developer in the world and has been on life support for months. A steady drumbeat of bad news over the past few weeks has accelerated what many experts warn is inevitable: failure.

Rating agency Fitch said last week that the default “looks likely.” Moody’s, another rating agency, said Evergrande was strapped for money and time. Evergrande faces more than $ 300 billion in debt, hundreds of unfinished residential buildings, and angry vendors who have shut down construction sites. The company even started paying overdue bills by selling unfinished properties.

Observers are watching to see if Chinese regulators keep their promise to clean up the country’s corporate sector by letting “debt bombs” like Evergrande fall.

How did Evergrande become such a problem?

In its heyday a decade ago, Evergrande sold bottled water, owned China’s best professional soccer team, and even took a brief interest in pig farming. It has grown so big and sprawling that it even has a unit that makes electric cars, although it has delayed mass production.

Today, Evergrande is seen as a rocky threat to China’s biggest banks.

The company, which was founded in 1996, took advantage of China’s epic real estate boom that urbanized large swathes of the country and left nearly three-quarters of household wealth tied up in housing. This has placed Evergrande at the center of power in an economy that has relied on the real estate market for supercharged economic growth.

Its billionaire founder, Xu Jiayin, is a member of the Chinese People’s Political Consultative Conference, an elite group of politically well-connected advisers. Xu’s connections likely gave creditors more confidence to continue lending money to Evergrande as it grew and expanded into new businesses. Eventually, however, Evergrande found himself with more debt than he could afford.

In recent years, she has faced legal action from buyers who are still awaiting completion of apartments they have partially paid for. Suppliers and creditors have claimed hundreds of billions of dollars in unpaid bills. Some have suspended construction on the Evergrande projects.

Why is the company in so much trouble now?

Evergrande could have continued if it hadn’t been for two problems. First, Chinese regulators are cracking down on the reckless borrowing habits of real estate developers. This forced Evergrande to start selling part of his sprawling business empire. It is not going so well. It has yet to sell its electric vehicle business, despite discussions with potential buyers. Some experts say buyers are expecting a fiery sale.

Second, the Chinese real estate market is slowing down and the demand for new apartments is lower. This week, the National Finance and Development Institution, a leading think tank in Beijing, said the housing market boom “has shown signs of a turning point,” citing weak demand and slowing prices. sales.

Much of the money Evergrande has been able to raise comes from pre-sold apartments that have yet to be completed. Evergrande has nearly 800 unfinished projects across China and up to 1.2 million people are still waiting to move into their new homes, according to a REDD Intelligence study.

Evergrande cut prices for new apartments, but even that failed to attract new buyers. In August, it achieved a quarter of its sales less than a year ago.

Will Chinese regulators step in to save it?

Beijing will be tempted to say ‘no’, but a collapse could cause serious damage, leaving domestic owners, suppliers and investors – potentially millions – unhappy. And Beijing has finally decided to support other large companies that have encountered big problems in the past.

For years, many investors gave money to companies like Evergrande because they believed that in the end Beijing would always step in to save it if things got too volatile. And for decades, investors have been right. But in recent years, authorities have shown a greater willingness to let companies go bankrupt in order to bring China’s unsustainable debt problem under control.

Authorities brought Evergrande’s leaders to a meeting last month and told them to get their debt in order. They also continued to tell its banks to cut back on developer loans.

How would the failure of Evergrande affect the Chinese economy?

A central bank campaign to bring home debt under control and reduce the banking sector’s exposure to distressed developers should mean that an Evergrande bankruptcy would have less impact on China’s financial system.

The reality is perhaps more complicated.

The panic of investors and homebuyers could spill over into the real estate market and affect prices, thereby affecting household wealth and confidence. It could also shake up global financial markets and make it more difficult for other Chinese companies to continue to finance their operations with foreign investment. In the Financial Times last week, billionaire investor George Soros warned that an Evergrande default could crash the Chinese economy.

Chen Zhiwu, a finance professor at the University of Hong Kong, said failure could lead to a credit crunch for the entire economy as financial institutions become more risk averse. A failure by Evergrande, he added, was “not good news for the financial system or the economy in general.”

Not everyone is so pessimistic. Bruce Pang, an economist at China Renaissance Securities, said a default could lay the foundation for a healthier economy in the future. “If Evergrande failed with the fading belief that ‘too big to fail’ it would prove Beijing’s greater tolerance for defaults despite short-term pain and disruption,” Pang said.

Should we worry foreign investors?

Foreign investors are due to pay $ 7.4 billion in Evergrande bonds next year alone. At various points throughout the year, they panicked, sending secondary market bond trading to new depths. Over the past week, Evergrande bonds were going at 50 cents on the dollar. Its debt trading was so frantic at one point that regulators briefly halted trading.

The company’s main listing in Hong Kong has lost more than three-quarters of its value over the past year.

Foreign investors fear that if Evergrande fails, all the money owed to them will vanish into thin air. Beijing officials have indicated they are no longer willing to bail out foreign and domestic bondholders. In any bankruptcy proceeding, they would be at the bottom of the list of creditors to get any of the assets of the Chinese company.

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