Markets around the world are at an all-time high, however, a few days ago, a small bump in this avarice concerned many, as there was no reason for them to be down. Upon inspection, the crippling was traced back to the debt crisis of the second-largest real estate company of China – Evergrande. Many are comparing this to the Lehman Brothers’ bankruptcy, which triggered The Great Recession. Here is why the world is concerned.
Evergrande’s Debt
To understand the debt crisis of Evergrande, one must grasp the sheer magnitude of this company.
Evergrande has 280 real estate projects in over 1300 Chinese cities. Every fourth apartment sold in China is of Evergrande. It has over 1.2 lakh employees. Furthermore, it is in association with over 38 lakh contractors. Last year, its sales accounted for over 108 billion dollars or 8 lakh crore rupees. Real estate holds for roughly 30% of the Chinese GDP. One is bound to wonder what made a company of such stature go to total financial wasteland.
Evergrande didn’t end up where it is today out of the blue, its condition is a product of its incompetent executives and the policies they recurringly incorporated. The beginning of the end can be traced back to 2000 when the Chinese real estate market was BOOMING. To sustain this boom, the Chinese Communist Party (CCP) with their national banks decided to initiate an extremely relaxed policy towards lending money to real estate businesses. To capitalize on this opportunity, Evergrande took a large number of loans from the nationalized financial institutions. Subsequently, they bought lands and built residential buildings in numerous cities. This practice is customary for real estate companies, however, Evergrande abused the Chinese real estate lending policy and took a ludicrous amount of loans (7% of total Chinese loans ever), which today account for the massive 300 billion dollars or 22 lakh crores liability it has. This makes it the biggest indebted company of the world. It has taken loans from over 171 banks and 121 financial firms. Its liability grows by 2000 crores daily.
The CCP took notice of its relaxed policies’ ramifications and in 2020 introduced a revolutionary new law. This law is popularly called The Three Red Lines. This restricted Evergrande from taking more loans. This disrupted the balances of the company, as it was so spoilt by loans, that it had no other major source of capital. Evergrande needed a solution, and they needed it quick. So, they introduced Wealth Management Products. These products issued bonds to the general public of China, with a promised (by Evergrande) return of 8%-12%. These bonds were categorized in the safe category of fixed income products. This safe categorization coupled with the overall massive image of Evergrande as a Fortune 500 company incentivized the general public to buy these bonds. Furthermore, Evergrande forced its employees to buy these bonds, whose sell collected over 6 billion dollars.
On the business end they were struggling as well, you see, not only Evergrande but the entire real estate sector capitalized off the relaxed CCP policy and took out an immense number of loans to buy land and build buildings. However, the land itself is limited.
With limited land and essentially unlimited capital to buy land, the price of land skyrocketed. To the point at which, the people cannot afford to buy it. This resulted in the rise of ‘ghost towns’. Decreased demand and increased supply caused the prices to plummet. This instigated the decline of the Chinese real estate market.
Why the world is concerned
To understand why the world is concerned we must remember how The Great Recession showed the interconnected nature of the contemporary world economy. It is certain the if Evergrande announces bankruptcy, China will witness extreme turmoil. As former US Secretary of State puts it ‘if they’re too big to fail... they’re too big'. The beginning of the end maybe upon China as massive real estate companies who took innumerable amounts of loans, like the HNA group are one by one filing for bankruptcy.
As mentioned earlier, real estate accounts for 30% of the entire Chinese GDP. The Chinese GDP is bound to experience extreme contractions due to this. Here is where things get global, China has the largest Foreign Direct Investments (FDI), worth well over 150 billion dollars. Not only China experiences the biggest inflow of FDIs, it also is one of the biggest outflow(er) of FDIs, with investments in nearly every part of the world. Chinese real-estate companies have invested in the public U.S. dollar bond market for $274 billion in the last five years alone.
It accounted for 84% of HSBC’s profits in 2020, while also contributing 81% Standard Charterer’s profits. China is arguably the biggest player in the global economy, acting as THE LAND for manufacturing products of all and every kind. These events poise the national banks of China to follow an extremely stringent capital loaning policy in the future, which may cause a reduction in Chinese companies, services, and software from which the world benefits. China is the world’s factory, every second product sold on Earth is made in China.
Apart from these hellish economic conditions, several protests nationwide are also taking place, the magnitude of which have only been matched with the ones who changed the authority. These protests are taking place because, the CCP favours the business whose leaders are partisans, like Xu Jiiayin of Evergrande, but heavily and sometimes unlawfully prosecutes the businesses which are run by rather critical leaders, like Jack Ma of Alibaba. A social uproar may cause strikes and vandalism on factories, causing a heavy blow to companies invested in China.
For an example of just how connected global economies are, one may consider the fact that as the news started coming out of Evergrande’s Debt Crisis, global exchanges faced contractions. For instance - Indian steels’ largest importer is China, the steel, which is used to build buildings, the buildings which are made by real estate companies, companies who are in shambles. This caused the Indian steel index to contract by 5%, which contains companies like Tata Steel. Prolonged losses for Tata Steel will force it to reduce its number of employees and reduce its overall expenses, thus increasing Indian unemployment and decreasing the quality of steel Indians get. This supply chain is just an example of the millions of supply chain China orchestrates. Turmoil in China means turmoil in the entire planet.
- Lorik Yadav
Sources - Wall Street Journal, The Economist, New York Times, Business Standard
Kommentare