A consensus that the entire world can shake hands on is that 2021 has been a defining year for all regions far and wide. With COVID-19 as the backdrop, it was either a watershed moment (though this was a rare incident) or a cannonball that decapacitated entire economies by reducing them into mere nothingness. However, amidst all the crumblings, it is not an exaggeration to say that the hit that the global real-estate industry took is one that can be recorded at the highest point on a Richter scale. And at the centre of this discussion, quite increasingly as of recently, is China’s Evergrande; a real-estate empire that is crashing and disintegrating and affecting economies far and wide. While COVID-19 acted as a catalyst behind this phenomenon, studies indicate that Evergrande’s meltdown had been a long time coming.
Evergrande’s descending arc
It started off small and simple. Hui Ka Yan’s (the CEO of Evergrande) initial strategy was quite straightforward: he would secure loans to purchase land, then market and sell properties on that land before they were even constructed. The proceeds from these pre-sales were then used to repay the lenders and fund the subsequent real estate ventures.
This formula proved incredibly profitable for a span of two decades, commencing in the mid-1990s, thanks to the meteoric rise in Chinese property prices. This exceptional success not only elevated Hui from a rural village and his previous job in the steel industry but also bestowed upon him the title of China’s wealthiest individual. Additionally, this strategy propelled his company, China Evergrande Group (listed as 3333.HK), into a colossal real estate conglomerate.
But then it fell from grace. As Evergrande continued to expand limitlessly, so did its debt. As a result, the company chose the easiest way out by resorting to anomalous and problematic strategies to generate funds. In 2016, it became evident that one of Evergrande’s subsidiaries was actively promoting the purchase of financial products from the company’s wealth-management division among its employees. This move was intended to channel funds into property development projects, as reported by international media.
By 2021 Evergrande was the poster child of China’s debt-fuelled property crisis because it was revealed that its debt to investors exceeded US$ 300 Bn. Overtime, from being the example that you could look up to, it became the ‘bad’ apple that everyone warned you to steer clear of. During the first half of 2023, Evergrande disclosed losses amounting to 33 billion yuan (equivalent to $4.53 billion). This represented an improvement when compared to the preceding year when they had reported a loss of 66.4 billion yuan during the same period. However, upon the resumption of Evergrande’s shares trading after a 17-month hiatus, the company witnessed a substantial decline. The sharp drop in its share price in August 2023, resulted in a staggering 79% decrease, effectively erasing $2.2 billion from the company’s total market value. And because of all of this, Evergrande’s chairman has been placed under police surveillance.
China has established itself as a world power that has an unrivalled grip on the global economy. Real estate is 30% of China’s total GDP. Evergrande has been one of the key players in uplifting China to that position. However, Evergrande’s tumultuous financial situation and the company’s current failure to meet its obligations on its US dollar bonds raise serious concerns about its future stability. A potential collapse wouldn’t only have ramifications within China, where Evergrande is a major employer and plays a significant role in the housing market. It could also send shockwaves globally. This domino effect might result in layoffs, a downturn in the housing market, and an economic slowdown in China, all of which would inevitably have repercussions on a global scale.
A house of cards situation
The quicksand that China is currently in is not an isolated incident but is one part of a troika of depreciating demand, ballooning debt and an ageing population. The Evergrande saga has exacerbated the issue on a local and a global scale as well. To begin with, the unfolding Evergrande situation has indirectly influenced the US bond market. The recent increases in long-term bond yields in the United States have been partially influenced by the backdrop of Evergrande’s crisis. This has prompted market participants to reassess their confidence in the strength of China’s economy. A weakened Chinese economy could lead to reduced interest in US assets, particularly treasury bonds, potentially resulting in higher interest rates in the US. Moreover, it could also have an indirect impact on the U.S. real estate sector. While the US real estate market is significantly larger and more stable compared to the Chinese market, the Evergrande situation’s crumbs can have a ripple effect on the US.
Also, a reduction in Chinese interest in US real estate may lead to a decline in property prices as it exerts downward pressure on demand.
Furthermore, the reach of this crisis can travel as far as Australia as well. As explained in ABC News, the Reserve Bank Of Australia (RBA), in its financial stability review that was published on 6 October 2023, stated despite direct connections between mainland China’s financial system and the banking systems of advanced economies being relatively limited, it’s important to note that Australia wouldn’t be completely shielded from the consequences. If a widespread financial crisis were to occur in China, its primary impact on advanced economic-financial systems would be through its influence on Chinese trade and a general surge in risk aversion within the global financial markets, as highlighted by the RBA.
China’s measures to reduce risk and enhance housing affordability have resulted in a stringent crackdown on the flourishing real estate sector, affecting numerous property developers. Evergrande’s challenges are deeply linked to these regulatory actions, underscoring the housing crisis that has affected the world’s second-largest economy in recent years. Even China’s largest real estate company, Country Garden Holdings Co., is teetering on the edge of default and is anticipated to announce financial losses for the first half of the year. The world either treats this as a trial and error situation that taught them a lesson or takes it as a precedent to pay homage to the adage ‘history repeats’.
(Sandunlekha Ekanayake)