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In the last 2 decades, China has grown from being an agricultural nation to an international manufacturing hub and has emerged as a strong economy in the region.
Evergrande is the largest real-estate company in China, however , it is in serious debt of about 300 billion USD.
The stock has fallen to one-sixth of what it was a year ago, and the bonds have devalued to 30-40 cents a dollar. To understand what impact this can have, we need to understand how big the real-estate market in China is, and how Chinese people think of owning property.
The real-estate investment is 13% of China’s GDP, while historically in the United States, this figure has been about 5%.
People in China tend to invest in real estate for 2 major reasons.
- The prices of property in China have skyrocketed 2015 onward and continues growing, people tend to look at it as a safe investment.
- It is risky to invest in private firms through the stock market because of the uncertainty of an authoritarian rule. US investors hold about 34 trillion dollars in stock markets, while Chinese investors only hold 8 trillion dollars.
More than 80% of holdings of the Chinese middle class lies in real estate. This explains the huge demand for a real-estate market. Evergrande takes advantage of this demand, with the vision of expansion of its business.
It took loans from nationalized banks, distributed bonds, and also received payment for its projects from the people beforehand, with promise to complete the construction in 5-6 years.
As COVID-19 hit and the world was at standstill, the company was not able to reach its target, and amassed liabilities worth 300 billion USD, with more than 16 lakh apartments under construction. The company is going through a cash crunch and is speculated to default on some of its loan payments.
What will happen if it defaults on loan?
If Evergrande defaults, it will have a ripple effect on all other companies working in the sector. The global supply chain can be affected miserably by the fall. Getting credit will become problematic for other companies. It is also being compared to the ‘Lehman brother’ fall that led to the global economic crisis in 2008.
Although 300 Billion USD is merely 1% of China’s total debt, the Chinese Communist Party (CCP) has denied providing any bailout package for the company, as the main problem lies in the excessive debt that companies have in China. Debt to GDP ratio is 3:1, if it bails out Evergrande it will have to change its policy for other companies as well.
As most of the loans and debt taken are from nationalized banks, there maybe a serious repercussion and credit crunch in China, this can surely lead to a slowdown in the Chinese Market.
It seems unlikely that CCP let the company go to the wall with investors losing money. CCP is observing the current situation meticulously, and may ask a state owned enterprise to infuse some capital to prevent the company from crashing.
This article has been written by Rutam Pimplapure for The Paradigm
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