The Guardian

What’s the problem and why does it matter?

Vincent Ni

The prospect of the Chinese property company Evergrande sinking under its $300bn debt is causing anxiety across the global economy. Here we examine why

What is Evergrande?

Evergrande Real Estate owns more than 1,300 building projects in more than 280 cities across China.

Founded by the former steel executive Xu Jiayin in 1996, it is now China’s second-biggest property developer by sales.

Its businesses range from property development to wealth management to food and drinks.

It’s also a familiar name to Chinese football fans as it owns one of the country’s biggest teams – Guangzhou FC.

A booming business that has tapped into many sectors of a growing economy has also made Xu one of the richest members of China’s business elites: according to Forbes magazine, he has a personal fortune of about £7.75bn.

Why is it in trouble?

In short, mounting debt and changing regulation. Evergrande’s troubles came after years of unrestrained expansion, which saw the company grow in size and assets, but also in debt. It is now labouring under a crushing debt pile of more than $300bn.

Tomorrow the company is due to make interest payments of $84m on its offshore bonds, but lenders are not holding their breath.

The embattled developer is also a casualty of Beijing’s changing approach to managing China’s gigantic economy. Shortly after he came to power in 2013, President Xi Jinping said that China needed to “shift the focus to improving the quality and returns of economic growth … to pursuing genuine rather than inflated GDP growth”.

Reducing the debt has become a major part of Xi’s effort to minimise systemic risks. It’s easier said than done, but Beijing last year introduced the “three red lines” for selected developers, which severely limits their capacity to borrow.

In theory, the new rules would force the entire real estate sector to deleverage in order to improve financial health. In reality, things seem to be playing out in a messy way. Evergrande had offered its properties at a discounted rate to ensure enough liquidity to keep the business afloat. But the music has stopped, with buyers losing confidence in an inflated property market ripe for a price correction.

It also pressured staff into lending it money. The loans were presented as high-interest investment schemes, but those who did not take part risked losing their bonuses. This month, Evergrande stopped paying back its employees. Now they are gathering on the streets outside the company’s offices, demanding their money back.

Evergrande’s share price has tumbled by more than 80% this year. Credit ratings agencies have also downgraded its bonds.

What is the significance for China?

For the government, the biggest fear is a potential spillover effect hitting the wider Chinese economy.

‘Default may be a drag on the sector, but we think it is far from being China’s Lehman moment’ Barclays analysts

The worsening geopolitical relationship with the west, Covid, as well as the strengthened ideological campaign to assert the influence of the ruling Communist party in the economy have led to fears of a sustained slowdown.

Reportedly, Evergrande also owes money to 171 domestic banks and 121 other financial firms. So if it defaults completely, there will be consequences for the banking system. A credit crunch could follow, analysts fear, which would be bad news for China and the global economy. UBS estimates there are 10 developers with potentially risky positions with combined contract sales three times those of Evergrande.

Beijing is facing a dilemma. If it steps in to bail out Evergrande, what message will that send to other heavily indebted developers? If it does not help, the fallout could spread to other sectors of the economy.

What are the international implications?

The short answer is: it’s hard to tell. Nobody really foresaw the implications of the fall of Lehman Brothers more than a decade ago. However, “a possible Evergrande default could be a significant drag on the property sector”, said Barclays analysts in a note. “But we think it is far from being China’s Lehman moment.”

Jimmy Chang, chief investment officer at Rockefeller Global Family Office, thinks the ripple effect could extend beyond China. He told CNBC: “If China were to have a serious economic issue because of China Evergrande, the rest of the global economy would have contagion from it.”

Markets were spooked on Monday, with America’s S&P falling 1.7% after Evergrande closed 10% lower in Hong Kong – the weakest level since May 2010. But the territory’s Hang Seng index recovered yesterday, closing up 0.5%, and the S&P has also regained lost ground.

Will Evergrande collapse?

The demise of the company is expected. If handled well, however, the process could inject momentum into Xi’s reform of the Chinese economy.

“We think it is difficult for Evergrande to meet its liabilities,” said Tao Wang, chief China economist of UBS. “Project delivery will be the most important from a social stability point of view. Hence, home buyers and suppliers are most important among its stakeholders.

“We think a possible scenario is segregation of project companies from the group to ensure the asset value is materialised and the cash flow is used for project construction only,” she added.

Financial

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2021-09-22T07:00:00.0000000Z

2021-09-22T07:00:00.0000000Z

https://guardian.pressreader.com/article/282235193800401

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