China’s-Evergrande - Poster Child Of Debt Fueled Growth

by Ashish JoshiSept 24th, 2021

US$ 300 Billion debt, operations across 280 cities and 1400 ongoing projects – That’s China’s real estate giant Evergrande, a fortune 500 company. Evergrande also has interest in Electronic vehicle, Food and beverages, Theme Park etc. Its China’s largest real estate player Listed in Hong Kong and based in the southern Chinese city of Shenzhen, it employs about 200,000 people. It also indirectly helps  more than 3.8 million jobs each year.

Evergrande has penchant to engage in new extravaganza : It's currently working on creating the world's biggest soccer stadium, assuming that construction will complete next year as expected. The $1.7 billion site is shaped as a giant lotus flower, and will eventually be able to seat 100,000 spectators.

Currently Evergrande is on the verge of collapse if not for Government intervention. The stock has lost more than 80% of its value.

The troubles of Chinese conglomerate Evergrande have dominated headlines after it warned once again that it could default on its astronomical debt because of a cash crunch. Its also termed as China’s Lehman crisis.

The relentless pursuit of growth through leverage  increased the company’s total debt to equity ratio to 2.65, double of its local peers such as Vanke China. The company also has a very high Total Debt to EBITDA ratio of 6.89 compared to its competitors Country Garden (1.22) and Vanke China (1.07). Despite this, Evergrande has not relented in its active acquisition, spending USD 606mn to acquire a Hong Kong residential plot above market rates in and CNY 2.3bn on a mixed-use site in Shanghai.

Was this expected or just a blip in fast growing Chinese economy?

As China’s property market has been on a tear in recent years, many companies have leveraged up to take advantage of the breakneck speed of China’s urbanization. With the sector being so integral to the Chinese economy, accounting for 28% of the nation’s GDP , the government decided to rein in developers by crackdown on excessive debt and risky lending from shadow banks to reduce the sector’s default risk. In August, the People’s Bank of China (PBOC) put in place a new policy dubbed ‘the three red lines’ that would come into effect in 2021. This policy will restrict the issuance of interest-bearing debt by property developers if they cross the following ‘three red lines’: 70% debt-to-asset ratio; 100% net debt-to-equity ratio; and 100% debt-to-cash ratio. Evergrande has already crossed all three of these restrictions, disqualifying it from issuing new debt once the policy comes into effect.

Evergrande's borrow-to-build model was enabled by a government reliant on property sales for revenue and unwilling to bite the bullet on runaway indebtedness for fear that a collapse in prices would have devastating consequences for a country in which property accounts for 40% of household wealth, analysts, academics and economists say.

UBS estimated there are 10 developers with potentially risky positions accounting for combined contract sales of 1.86 trillion yuan ($287.92 billion), nearly three times Evergrande's total.

China’s debt has risen dramatically in the past decade, largely the result of credit fed to state-owned enterprises in the wake of the global financial crisis. To some, the debt mountain represents a threat to China’s stability and even the world’s economic health, while others argue such fears are overdone as most of the country’s debt is state owned and therefore, they say, manageable. 

China’s debt is more than 250 percent of GDP, higher than the United States. It remains lower than Japan, the world’s most indebted leading economy, but some experts say the concern is that China’s debt has surged at the sort of pace that usually leads to a financial bust and economic slump. 

The government reaction in the wake of Evergrande will be closely watched in global financial market. Experts feel that years of debt fueled growth is slowly unravelling and if problems is deeper than what is visible, it will lead to chaos in China as well as global economy. Market is expecting the Chinese Government to intervene and handle the crisis. However, fault lines appear very deep in the opaque structure of Chinese system which may throw new surprises and if that happens confidence in the market will take large beating.