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What is the Evergrande Crisis?

In a globalised world, in which businesses and business sentiment are linked tightly, an event of a big scale in a large country cannot be wished away or ruled out. Such events could have consequences or repercussions not only for the people in the place of its origin but also for those associated with the place of its origin.

In March 2021, Ever Given—one of the biggest container ships in the world—blocked the Suez Canal. It brought global trade to an almost grinding halt. Now, the recent event which has added turmoil in global financial markets is the crisis related to the Chinese real estate company Evergrande Group. The abrupt volatility observed world over needs careful examination and deep and sound reflection.

So, what is this crisis about? And most importantly, what can we learn from this crisis? Let us understand these aspects in a simple manner:

What is Evergrande?

One of the largest property developers, Evergrande has a wide range of business interests such as electric vehicles, theme park, football team, football stadium and mineral water. Founded in 1996 by Xu Jiayin, the company has built many apartments, towers, offices, and malls. The company has developed projects in over 170 cities in China. It has assets worth USD 350 billion. It is one of the largest private sector conglomerates in China. Its founder Xu Jiayin topped the richest entrepreneur list in China in 2017. He had a net worth of USD 43 billion.


Why is it in the news?

Evergrande has outstanding bonds worth USD 300 billion. It also has payments outstanding to its suppliers to the tune of USD 103 billion, according to news reports. The developer has been reporting slow or weak sales. Against this backdrop, the recent crackdown by the Chinese Government in the form of strict limits on how much property developers can borrow has made the business situation difficult for Evergrande. It has been struggling to raise money.

According to news reports, bonds issued by Evergrande worth USD 83 million are due for repayment on September 23. It is believed that the company may not honour its commitment. If it defaults, financial markets worldwide will bear its brunt.


How could the Evergrande crisis impact markets?

The corporation has borrowed from banks, institutional investors and even individuals. There is a clear stress visible as the company is trying to sell properties and assets to raise money. Investors are demanding repayment from the company. Banks which lent to the company may face dire consequences if the company defaults. Institutional investors have to provide for this possible default in their books. Investors will see the marked-down impact on their investments if the company defaults. Some institutional investors and banks who have lent to Evergrande may have raised money overseas. This makes overseas investors vulnerable and puts them in a precarious situation.

Evergrande may also have some overseas investors who will take the trouble in their respective countries. As financial markets start discounting a possible default by pulling down prices of bonds, the volatility in asset prices can be seen. Markets in China, South Korea and Japan are under pressure. High-yield bond prices in China are falling reflecting investors’ urge to exit the asset class. Though the exact impact can be ascertained only after the default, investors must be alert. The only way to reduce the damage is to bail out this company by its government.


What are the lessons for investors?

A key mantra to follow in investments is: Do not ignore credit risk. Investors need to follow a measured approach. If you have the skills-set or lack the time to measure the credit risk, assess the changing situation and take informed calls. For stocks of leveraged companies you have to be doubly careful or may want to consult an advisor.

If you are keen on taking some credit risk for some extra returns, it is better to go through pooled vehicles such as credit risk funds. These funds follow a transparent mechanism and are professionally well-managed.


Recent developments

The Evergrande crisis is a developing story. According to the latest reports, the real estate behemoth has agreed to pay interest on the domestic bonds. At the same time, the company is also reportedly trying to raise funds to tide over the rough times. Meanwhile, the Chinese central bank, People's Bank of China has injected 90 billion yuan (~$14 billion) into the banking system, to provide support to the banking system and ease investor sentiments.

Categories: News