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Thais Ayuso: An “Ever-Greater” Failure

Updated: Jan 27, 2022


The next “Lehman Brothers” (Egan, 2021), “Evergrande missed coupon payments”, “the biggest test that China's financial system has faced in years.” (Wall Street Journal, 2021). Lately, the world of finance has witnessed a sudden upheaval in light of the developments regarding China’s Evergrande Group.


The news story received public attention when images of angry Chinese citizens protesting and forcing their way into the Evergrande Headquarters in Shenzhen, China were circulated (see Image 1). However, the news media mainly covered the emotional aspect of the story, focusing on citizens demanding the return of their savings. The coverage made for a good ‘clickbait’ news story, yet it did little to explain why this particular company has the whole financial sector on its toes. Why do financial analysts in the US or Europe care so much about a Chinese property developer? Why does everyone keep comparing it to the Lehman Brothers? And why are financial analysts so worried about this company and what happens to it?


Let’s start with a quick overview of what Evergrande is and what the company actually does. Evergrande is one of China’s largest real estate developers — it is part of the Global 500 companies hence, one of the biggest businesses by revenue. The company mainly made a name for itself in residential properties, nonetheless, it also invested in a vast array of other sectors, including electric vehicles, soccer teams, and theme parks.


This diverse investment is partially responsible for Evergrande ending up in its current situation. Straying away from its business core, contributed to Evergrande taking on more and more debt to support its various ventures. Nonetheless, problems really started to arise during the pandemic lockdowns last year, when property sales were down for months. This led to a ‘cash crunch’ (i.e. when an organization does not have enough liquid assets, like money, to operate successfully or up to normal standards) during the fall of 2020. Parallel to these developments, China started to crack down on businesses, borrowing massive amounts to expand their market value, through the so-called “three red lines” policy. The real-estate developer giant owes in total a sum of around $88 billion, with about 42% approaching its due date in less than a year. This resulted in Evergrande taking on new debt, therefore further exacerbating their liquidity problems. The financial problems grew to the point where, this summer, the company started paying some suppliers with unfinished apartments instead of money.


All these struggles sparked the aforementioned protests by investors in front of Evergrande offices all over China. This fall, the company reached its tipping point. Just a few weeks ago, on Sept. 23 the company missed an $83.5 million interest payment deadline on some of its dollar-denominated bonds (i.e. a debt instrument that companies can use to borrow and raise money on financial markets). Although it managed to resolve an interest obligation on a yuan-denominated bond, the company has kept investors in the dark regarding whether they will pay them back in assets or in cash. The company now has 30 days to make good on the outstanding dollar amount still due, before it is potentially forced to declare (selective default).


So the question remains: if this is happening all the way in China – why do we, in Europe, care? What impact could this have here? Although there was some speculation of a Lehman Brother-like default (the bankruptcy that set off the 2008 financial crisis), financial analysts doubt that the Evergrande debacle will have the same devastating effect. This is mainly due to the extraordinary grip that the Chinese government has over its banks and other key actors. Furthermore, one could argue that Evergrande is a Chinese company that is “too big to fail”, meaning the Chinese government would be better off bailing them out than letting them default.


There are three major reasons why European and Western market analysts are worried about the Evergrande case. The main fear currently dominating financial markets is that of contagion, i.e. the spread of market disturbances – mostly on the downside – from one country to the other, a process observed through co-movements and co-dependencies in global financial markets. This suspicion is already taking shape with Chinese luxury developer Fantasia Holdings Group Co. missing a $206 million U.S. dollar bond payment on Oct. 4. Furthermore, on Oct 11th, Chinese property developer Modern Land Co. asked investors to defer repaying a $250 million bond due later this month. These types of co-movements within financial markets have investors worried the situation may also affect European investors and companies holding stakes in big Chinese development firms.


Another worry investors have, concerns the Chinese government’s lack of communication about its plans and strategies to address the growing burden that is Evergrande’s debt. Goldman Sachs warned that the current radio silence from Beijing could pose a “notable downside risk to growth”. This information asymmetry and lack of transparency by both Evergrande and the Chinese government has increased mistrust in the Chinese financial market by western investors, lowering incentives to invest further in Chinese markets in the future.


Lastly, and most importantly, the main issue that has been exposed during this crisis is China’s corporate debt problem. The main concern is that Evergrande is just a symptom of China’s debt-founded rapid economic growth. In 2019, China’s corporate debt-to-GDP ratio was at 153%, one of the largest in the world. Although about two-thirds of corporate debt is owed by state-owned enterprises to state-controlled banks, the problem of over-indebtedness still remains. This is mainly caused by a system in which risky entities were allowed to borrow for an extended period of time in order to boost job creation and economic growth in the wake of the 2008 financial crisis. Just recently, China started a deleveraging campaign to try and curb the massive amount of borrowing by its companies. Nonetheless, there are fears as to how smooth the descaling of debt can run and Evergrande’s struggles are not exuding confidence towards the world's financial markets. Paired with the ominous silence coming from the Chinese government, it remains to be seen how exactly western investors are to handle investing in China in the future.



Written by Thais Ayuso, Amsterdam Chapter of European Horizons.

Protest at the Evergrande Headquarters


Bibliography


Egan, Matt. 2021. “China Faces a Potential Lehman Moment. Wall Street Is Unfazed.” Cable

News Network, September 16, 2021.

https://edition.cnn.com/2021/09/16/business/wall-street-evergrande-china/index.html.


Mendell, Erin. 2021. “What Is China Evergrande, and Why Is Its Crisis Worrying Markets?”

The Wall Street Journal, October 8, 2021.

https://www.wsj.com/articles/evergrande-china-crisis-11632330764.


Ng, Serena, Alexander Gladstone, Gregory Zuckerman, and Justin Baer. 2021. “Evergrande's

Global Bondholders Didn't Receive Interest Payment.” The Wall Street Journal, September 24, 2021. https://www.wsj.com/articles/china-

evergrande-bondholders-in-the-dark-about-83-5-million-in-interest-payments-11632453719


Toh, Michelle. “5 Things to Know about the Evergrande Crisis: A Simple Breakdown.” Cable

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https://edition.cnn.com/2021/09/24/investing/china-evergrande-group-debt-explainer-

intl-hnk/index.html.


Venkat, P. R. 2021. “Chinese Developer Modern Land Asks to Delay Bond Repayment.” The

Wall Street Journal, October 11, 2021. https://www.wsj.com/articles/chinese-developer-

modern-land-asks-to-delay-bond-repayment-11633929338

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