Evergrande debacle and its global impact

Md Shakil Ahmad | Published: October 15, 2021 20:29:10

In our interconnected world, when any "too big to fail" company faces a precipitous decline in its share price, the ripple effect is felt everywhere, and when that company is Evergrande with asset worth equivalent to 2% of the world's second largest economy, the ripple becomes large waves. For the last two months, investors worldwide have been on their toes, worried about the future prospects of the world's fastest growing economy. There are lots of speculations regarding the extent and severity of this crisis. Some analysts are calling this event a 'Lehman Moment' alluding to the failure of the U.S. bank Lehman Brothers and posing a warning similar to the 2008 financial crisis, whereas others are less concerned because they are thinking that China's state-owned financial system will be there for Evergrande if needed to prevent any economic collapse. On the basis of a detailed anlaysis of these events, recent news, and expert analyses, I will be presenting my own exploration with actionable insights for relevant stakeholders in this article.
Evergrande was founded in 1996 by Mr. Xu Jiayinas a residential property development company for a burgeoning middle class. In a relatively short time his company became one of the largest in Asia making him the richest man in Asia. The main business of this company is to buy land from local governments, develop and sell residential apartments to customers. Typically the apartments are sold before construction is finished and the proceeds from those sales are used to finance further land purchases.
EVERGRANDE'S PROBLEM AT HAND
Evergrande's current problem is its gargantuan amount of debt which caused the company to miss deadlines on interest payments and eventually default, later warning investors in August 2021 that it is set to miss future deadlines. After the announcement, the share price dipped by 85% and its bonds, downgraded by Fitch and S&P, were traded 20 to 50 cents on the dollar. Total liabilities are worth over $300 billion and it has to pay around $37 billion in interest and maturing debt over the next one year . It already missed a coupon payment worth $83.5m coupon on its foreign offshore bonds, which has only 30 days before triggering a default. It was unclear about its future coupon payment as well. It owes money to around 171 domestic banks and 121 other financial firms .
In the event of Evergrande's collapse, the impacts can be grouped into two types:
IMPACTS: INSIDE CHINA
In the event of a collapse of Evergrande, the following domestic stakeholders will face the most negative impacts:
The 1.6 million customers who advanced around $200 billion and never received their apartments will potentially lose their money causing a nationwide upset and protests.
All related business partners including construction and design firms and materials suppliers will see a major loss, probably causing bankruptcy for many of them. Many have already brought lawsuits against the company, mounting extra pressure.
Many of the 200,000 employees working in the company might lose their jobs and the money invested by them in the Evergrande ($6 b) will vanish.
The financial market of China will take a major hit as Evergrande owes money to 171 domestic banks and financial institutions. This will have far reaching impacts because default from Evergrande will increase the bad loans for all of 171 financial institutions which will cause them to lend less as their required provision amount will increase. This might create a credit crunch where the domestic companies will find it hard to get loans at an affordable rate which will ultimately rein in the economic growth of China.
IMPACTS: OUTSIDE CHINA
Out of the mammoth debt of Evergrande (around $300 billion), foreign currency bonds constitute only $18 billion which include both Chinese banks and foreign financial institutions. Of this amount $7.4 billion is payable to foreign investors next year. Directly, on the event of a total collapse, all this foreign debt will vanish into thin air. Already the bond price tumbled to as low as 24 cents. An S&P analysis of the court restructurings of almost 50 defaulters in China showed that the average cash recovery rate for unsecured debtors was 23.7 percent . However, according to FT, direct spillover into the international market is limited beyond Asian high yield bonds. In terms of having a serious international ripple effect like the collapse of Lehman Brothers in 2008-09 financial crisis had, the probability is slim. There are several reasons for that. Firstly, unlike Lehman Brothers whose assets mostly constituted financial assets the value of which can rapidly vanish, the assets of Evergrande mostly include land and partially completed real estate projects the value of which is not volatile in the short run.Even if the value of the assets diminishes rapidly which is almost impossible, the Chinese banking system generates enough profit (1.9 trillion yuan) annually with reserves of 5.4 trillion yuan against bad loans, that it can easily neutralize the impact . Lastly, the grip and resource that the Chinese government has over its economy enables it to implement any policy it wants as per the situation demands.
According to the IMF's Chief Economist, "China has the tools and the policy space to prevent this turning into a systemic crisis." According to the Fed Chair "there's not a direct United States exposure," and the Chinese banks are "not tremendously exposed" either. The contagion danger was similarly dismissed by European Central Bank President Christine Lagarde, who thinks direct exposure in Europe is "limited." Agreeing with these experts, I also speculate that Evergrande is not a "Lehman Moment" for China or the world.
COMMODITY SECTORS IMPACTED GLOBALLY BY EVERGRANDE FALLOUT
The Evergrande fallout will certainly have an impact on the overall real estate market. Confidence in all property developers will wane. People who have already put their money out for an apartment might want a refund and new customers will think twice before investing in this sector. Over capacity is already hampering the sector and the current fallout will, according to experts, be the last nail in the coffin. But will the impact be limited to real estate only? The basic materials sector in the UK is already down by 4.5% as of September 20, 2021. In Europe, steel company Arcelor Mittal dropped by 6% the same day. The commodities, as indicated by the market movement, have already been adversely impacted because the real estate sector in China frequently requires them, such as steel for structuringor copper for wiring. To measure the extent of the exposure, Tom Price at Liberum conducted a brief analysis . Overall, Chinese real estate accounts for a fifth of all global copper and steel supply. Therefore, Evergrande's collapse is potentially a big deal to the commodity world.Commodity companies in Australia and India who export in large quantities to the Chinese real estate sector should be worried about their sales in China in the last quarter of 2021, while other countries importing these commodities should enjoy a better price.
SHOULD BANGLADESH BE WORRIED
In case of the collapse of Evergrande, Bangladesh will not be affected directly because I could not find Bangladesh or any Bangladeshi investor having any stake in Evergrande. Of course, if the overall Chinese economy crumbles because of Evergrande, Bangladesh might get affected to someextent.
In 2019, total imports from China were$17.3 billion. The main product items were Refined Petroleum ($861M), Light Rubberized Knitted Fabric ($749M), and Light Pure Woven Cotton ($710M). We can expect no direct impact of Evergrande fallout and Bangladeshi importers will not likely face any shortage there. On the other side, iron and steel import of Bangladesh in 2020 was 5.2% of total import ($ 2.4 billion) which is also one of the top 5 imports. Since the iron and steel demand will likely dampen for China's slowing real estate sector, there should be an oversupply of iron, steel and other materials in the international market. Therefore, the importers of Bangladesh can expect a lower price of those commodities in the next few months.
In 2019, Bangladesh exported $1.03B to China. The main product items were Non-Knit Men's Suits ($123M), Knit T-shirts ($120M), and Non-Knit Women's Suits ($87.4M). These products are also not in any way dependent on Evergrande fallout. Bangladesh does not export any luxurious products to China; therefore, the demand can be expected to remain stable in the near future.
A bailout or a weaker economy will have a devaluing impact on the Chinese currency. In this case, Bangladesh will be slightly benefitted because Bangladesh's import more from China than it exports.
Chinese FDI to Bangladesh, which in the most recent period has had an increasing trend, is likely to continue because of several other non-Evergrande-related factors like Chinese geo-political tensions with India, existing huge Chinese investment, control over the Asia pacific, etc.
At last, some experts are predicting that the Evergrande fallout might cause an Asian financial crisis similar to what happened in 1997-98 . In such a turn of events, Bangladesh might be slightlyexposed in the foreign currency market as well. Such types of impacts have historically never gotten so serious for Bangladesh.
Md Shakil Ahmad is a CFA and CAMS
shakil.ahmad@fulbrightmail.org