Evergrande’s collapse would have ‘profound consequences’ for China’s economy
Investors are bracing for the increasing risk that Chinese
real estate colossus Evergrande will collapse under the weight of more than
$300 billion of debt. But experts say the Chinese Communist Party will have no
choice but to save a company that is so emblematic of its economic growth model
– and whose collapse would send shockwaves across the global economy.
Western financial institutions think Evergrande has a bleak
future, if it has one at all.
JP Morgan made a whopping cut to its stock price target for
the business on Friday, to 2.80 Hong Kong dollars from $HK7.20.
This came after ratings agency Fitch downgraded the firm's
foreign currency credit rating from triple C plus to double C on Wednesday,
saying that a form of default “looks probable”. Ratings agency Moody’s lowered
Evergrande’s credit rating in the third time in three months – on the grounds
that its creditors faced “weak recovery prospects” if the company defaulted.
Evergrande is the world’s most indebted real estate
developer; $300 billion is roughly equivalent to the entire public debt of
Portugal. Unsurprisingly, senior executives admitted in August that they might
be unable to meet all of their financial obligations.
‘Debt-dependent growth model’
This poses a serious problem for the Chinese Communist
Party, as Evergrande is a longstanding symbol of the country’s very
economically productive urbanisation.
Also, Evergrande’s business model is representative of
“China’s highly debt-dependent growth model”, Jean-François Dufour, head of
French, China-focused consulting firm DCA Chine-Analyse, told FRANCE 24.
The company was founded in 1996, in the midst of the
Communist Party’s Herculean endeavour of moving hundreds of millions of Chinese
people from the countryside to the cities, creating a "very strong growth
of the Chinese real estate sector", Frédéric Rollin, an investment
strategy adviser at the multinational firm Pictet Asset Management, told FRANCE
24.
Evergrande was the main beneficiary of this boom. It pursued
a very aggressive growth strategy and was dependent on banks’ goodwill as it
accumulated a proliferating portfolio of real estate projects at a rapid clip.
This expansion continued over the decades, as shown by
Evergrande raising $722 million in its IPO on the Hong Kong Stock Exchange in
2009. The firm now controls 778 real estate projects in 223 Chinese cities,
directly employing nearly 200,000 people. Evergrande has claimed that it has
indirectly created more than three million jobs.
Huge debt pile
But at the beginning of the 2010s, in the wake of that
blockbuster IPO, Evergrande stretched its tentacles into an array of other
sectors. The company was in a “race against time to diversify its activities,
much more so than other Chinese real estate groups”, Dufour said. The Communist
Party had “made other sectors national priorities”, he continued.
Consequently, Evergrande acquired stakes in video streaming
companies, health insurers, milk farmers and pig-breeding co-operatives. It
also bought Guangzhou FC, a football club in the Guangdong region where it is
based, and built amusement parks. Evergrande’s latest diversification project
was an attempt in 2019 to start manufacturing electric cars – despite a lack of
any experience in this field.
Evergrande got its fingers into so many pies because it
wanted a presence in “a sufficient number of priority sectors so that the state
would be more inclined to support it financially when the weight of its debt
became too heavy to bear”, Dufour explained.
The debt is very heavy indeed. Evergrande is due to pay $15
billion to creditors by the end of 2021; but, as of late June, it had only $13
billion to its name. At the same time, the banks have become much more
reluctant to lend it money. “It’s become more complicated because of the
restrictive monetary policy the government is currently pursuing,” Rollin said.
Economic contagion risk
Evergrande has entered a downward spiral in which the banks
no longer want to give it the funds to finish its real estate projects,
depriving the company of new properties to sell and therefore of fresh funds to
repay creditors and reassure the banks.
“In a normal market economy, Evergrande would have gone
bankrupt a long time ago,” Dufour said. But the Chinese model of capitalism has
long encouraged the model of private debt.
“The rule was that as long as a company looked like it was
moving forward – with plenty of projects in the pipeline – the banks gave it
credit on the understanding that the strength of Chinese economic growth would
always deliver profits,” he continued.
This way of thinking meant that “in 2020, Chinese companies’
debt represented 160 percent of GDP, compared to just 85 percent in the US and
115 percent in the eurozone”, Rollin pointed out.
Companies like Evergrande find themselves in a tricky
situation now that Beijing has pushed heavily indebted countries to deleverage
over the past year.
But the Communist Party also faces a dilemma, as it needs to
prevent Evergrande from going under, to avoid the “profound consequences it
would have for the Chinese economy”, Dufour said.
If Evergrande went bankrupt, “at least one bank would go under”,
Dufour continued. “That may well push other banks to be more reluctant to end
to highly leveraged countries – and that would herald the end of China’s
debt-fuelled growth model.”
The real estate behemoth’s collapse would sent shockwaves
far beyond China. As the Financial Times noted: “Evergrande counts big
international companies among its investors, including Allianz, Ashmore and
BlackRock. A default is likely to have spillover effects on global markets,
where many investors have historically anticipated Chinese government support
at times of distress.”
Given Evergrande’s importance to the Chinese economy, “it’s
highly probable that the state will sort out a debt restructuring programme for
it”, Rollin said. In other words, Beijing will force creditors’ hands while
organising the sale of Evergrande’s non-core assets.
“This will likely mean putting the company under the state’s
control while it finds a buyer; an approach the Chinese government has adopted
before,” Dufour said.
But cleaning up a mess as big as a $300 billion debt pile
will not happen overnight.
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