Evergrande: The Lehman moment for China

In 2008, when Lehman Brothers declared bankruptcy due to the subprime mortgage crisis in the United States, shock waves were felt around the world. Now, the world is drawing parallels between the Lehman bankruptcy and an impending default by Evergrande. The world economies should brace up for one more economic disaster, only this time it’s by China.

This Lehman moment of China reminds me of IL&FS. But due to the swift action of the Indian government, no such crisis took place. The government-appointed board has been able to recover around 61% at IL&FS. The situation in the case of Evergrande is totally different and if not taken care of, ripples will be felt everywhere.

The images of hundreds of employees with boxes in hand leaving Lehman Brothers headquarters in New York City after the company filed for bankruptcy on September 15, 2008, became one of the lasting images of the global financial crisis. This became the perfect example of how a leading firm can come to ruin, dragging a nation and the world with it.

What is Evergrande?

Evergrande is one of the largest real estate development companies in China, founded in Guangzhou in 1996. It specializes in building and selling residential apartments for the country’s rapidly growing middle and upper classes, as well as building shopping malls and other commercial real estate projects.

Evergrande has its assets spread in diverse sectors, not just real estate. It has an electric vehicle company, a soccer team, and a bottled water business, among others. The company has started selling some of these assets as it doesn’t have any other means to repay the investors.

According to the company’s website, the real estate arm of Evergrande owns more than 1,300 projects in more than 280 cities in China. Evergrande Group says it employs 200,000 people total and its projects create more than 3.8 million jobs per year — leading some to suggest it has “too big to fail” status. The firm states it has some $350 billion in assets.

These are just the claims put forth by the company in order to save its tail but the real picture of this Chinese company is yet to come out. And obviously, the real picture will come out, only if China wills it to.

A modified script may now need to be written on China, which has emerged as world’s second-largest economy, and a challenger to the United States in economic and strategic clout.

What is the issue and why is it impacting global stock markets?

Essentially, Evergrande’s rapid growth has been fueled in large part by borrowing. As demand in China’s once-exploding housing market wanes, fears that Evergrande could default on its estimated $300 billion in liabilities have come to a head.

“The problem, in a nutshell, is property development companies tend to use a lot of debt to finance their operations, and in response to rising housing prices, the Chinese government has said for quite a few years that they want to find ways to restrain the demand and restrain the housing price increases,” Wei, who formerly served as chief economist of the Asian Development Bank(ADB), told ABC News.

“Previous attempts by the government have not been very successful, and I guess Evergrande decided that the same will happen this time,” Wei added. “So the last few years, while some of the property development companies have scaled down their operations, Evergrande was still charging ahead. And recently, a change in government policies has reduced demand for residential apartments quite a bit, so the company is having trouble selling apartments fast enough to meet their debt obligations.”

Evergrande is the most indebted real estate company in the world, currently, with over $300 billion in liabilities. Just for a comparison, Russia’s state debt in the year 2020 was $257 billion. By this comparison, you can estimate the effect it can have on China’s entire economy and obviously, ripples of such a massive disaster will be felt everywhere.

Is this China’s version of the global financial crisis?

It is seen generally that destabilized property markets are usually accompanied by suppressed consumer spending. So, if Evergrande collapses, the demand in China for international products, commodities, and services would potentially fall. This is surely going to affect markets everywhere since China is a major trading partner for over 100 countries around the world.