Turns out Evergrande was never too ‘grande’ to fail
Over the last couple of days, the Chinese company Evergrande has taken over the headlines due to fears of bankruptcy and a debt of over $300 billion dollars. And although this comes as a surprise to many, one must understand the history behind the Chinese financial market in order to grasp and comprehend everything that is currently happening. The exponential growth of Chinese stocks has attracted global attention over the last decades. China’s economic surge began with the re-birth of the Shanghai Stock Exchange in the late 1970s, this time adding company stocks and corporate bonds to their instruments.
By the end of 2012, China became the second largest economy by GDP size in both nominal and PPP terms, and the GDP per capita grew from $205 in 1980 to $6075 in 2012. More importantly however, throughout these last years China has shared the spotlight with the United States over the GDP by country share of the world. According to the official data of the World Bank, as of 2021, China’s GDP growth rate is higher than the US’s. with 8.44% and 6.39% respectively.
Nonetheless, one must keep in mind that the Chinese government has always regulated the stock market very strictly, and it is not completely open to foreign investors. These authoritarian and rigorous market regulations can be seen in the small percentage China has in the distribution of countries with largest stock markets worldwide. Using nominal GDP as a benchmark, the data provided by the World Bank shows that China has 17.7% share of the worldwide GDP, and therefore places itself in second place after the United States. Therefore, it is no surprise that China has great influence in the financial world.
However, the flow of shares traded and the market capitalization of the Shanghai Stock Exchange is extremely powerful. As of September 2, 2021, the market cap or total value of all securities traded on the Shanghai Stock Exchange was $7.27 trillion USD. Additionally, the trading volume of China’s stock market increased from 3,395.7 billion shares in 2011 to 16,745.2 billion shares in 2020. These substantial figures demonstrate the supremacy and influence of China’s stock market. It is crucial to understand that there is an interplay between the stock market and the real economy, and that financial markets drive economic growth. This is what led some Wall Street investors this week to compare Evergrande to Lehman Brothers, the investment bank that collapsed and paved the way to the 2008 financial crisis.
Evergrande is primarily a real estate developer that was founded in 1996 in Shenzhen, China. During that period, there was an enormous demand for housing in cities from the Chinese government, since they wanted to relocate people from the rural areas into the big cities. The Chinese real-estate industry is generally one of the main driving forces of the country’s economy, and Evergrande is one of the three largest companies behind it. It has more than 1,300 project sites in 280 cities, and it has over 800 development projects still in progress regardless of the lack of liquidity the company has been running in. It had promised to deliver apartments to around 1.5 million buyers, who are still waiting for their keys. The company aggressively borrowed money to buy more land to develop, but construction delays scared off buyers and created a vicious cycle.
The company’s founder Hui Ka Yan and the company benefited from China’s real estate boom, earning Mr. Yan over US $30 billion. But since their peak last July, the stock has tumbled 58 percent, and has impacted markets and alarmed investors worldwide. In fact, last Wednesday the stock erased an equivalent of $19billion dollars from its market value in the HK978. At the same time, last Monday the Dow Jones Industrial average lost 614 points, marking Wall Street’s worst day since May. This occurrence was mostly due to the fact that Evergrande is now the most debt-saddled real-estate company in the world, owing more than $300 billion to creditors, some of which were expecting the payment as early as this week.
Fears about Evergrande not being able to pay back its debts have also impacted equity benchmarks in Europe, with Germany and Italy losing more than 2%. The S&P saw it’s worst day since May, and in a worst-case scenario, credit markets around the world could freeze. Further along in the week, the markets stabilized thanks to an injection of short-term cash by the People’s Bank of China, along with an apparently resolved agreement on the coupon payment of 83.5 million dollars that was due on Thursday. The Chinese government cares a lot about stability, but saving the company could lead to ‘moral hazard’, since it could incentivize more bad behaviour and a tolerance for risky moves caused by the belief that the state will bail these companies out.
This has left the whole world wondering what is going to happen. US stocks edged higher in Thursday trades, rebounding from Monday’s Evergrande scandal. The S&P 500 was up 0.52%, the Dow Jones Industrial Average was up 0.79% and the Nasdaq Composite was up 0.37%. Nonetheless, Evergrande’s $300 billion debt problem will not fade away in the longer-term. And, following days of consistent losses, The Evergrande Group experienced a 17.6% jump in its share price on Thursday. Beijing’s financial regulators have asked the company to do everything in its power to avoid a near-term default on its bonds issued in US dollars, and are working on preventing a global economic fallout. Although the stock market seems to be getting back on its feet, it is crucial for investors to understand that this situation will most likely occur many more times with many different companies.
The $83.5 million coupon payment that was due last Thursday has left Evergrande with a 30-day limit to pay it. With over 200,000 employees and around 3.8 million indirect jobs a year, the default of the company could severely hinder China’s economy. The worrying aspect is that this is likely to not be the last large company in China to risk a full default, due to the current instability of China’s economy and stock market. Additionally, China’s likely unwillingness to commit to future bailouts due to the potential moral hazard it could pose, could also be a double edged sword due to the lack of alternative mechanisms to save other potentially at-risk companies. This leaves a lot of uncertainty in the Chinese market that investors and other nations alike are going to have to learn to live with, as the world’s largest economy continues to grapple with a challenging domestic economic scene.