Investors are bracing for the increasing risk that Chinese real estate colossus Evergrande will collapse under the weight of more than $300 billion of debt. But experts say the Chinese Communist Party will have no choice but to save a company that is so emblematic of its economic growth model – and whose collapse would send shockwaves across the global economy.
Western financial institutions think Evergrande has a bleak future, if it has one at all.
JP Morgan made a whopping cut to its stock price target for the business on Friday, to 2.80 Hong Kong dollars from $HK7.20.
This came after ratings agency Fitch downgraded the firm’s foreign currency credit rating from triple C plus to double C on Wednesday, saying that a form of default “looks probable”. Ratings agency Moody’s lowered Evergrande’s credit rating in the third time in three months – on the grounds that its creditors faced “weak recovery prospects” if the company defaulted.
Evergrande is the world’s most indebted real estate developer; $300 billion is roughly equivalent to the entire public debt of Portugal. Unsurprisingly, senior executives admitted in August that they might be unable to meet all of their financial obligations.
‘Debt-dependent growth model’
This poses a serious problem for the Chinese Communist Party, as Evergrande is a longstanding symbol of the country’s very economically productive urbanisation.
Also, Evergrande’s business model is representative of “China’s highly debt-dependent growth model”, Jean-François Dufour, head of French, China-focused consulting firm DCA Chine-Analyse, told FRANCE 24.
The company was founded in 1996, in the midst of the Communist Party’s Herculean endeavour of moving hundreds of millions of Chinese people from the countryside to the cities, creating a “very strong growth of the Chinese real estate sector”, Frédéric Rollin, an investment strategy adviser at the multinational firm Pictet Asset Management, told FRANCE 24.
Evergrande was the main beneficiary of this boom. It pursued a very aggressive growth strategy and was dependent on banks’ goodwill as it accumulated a proliferating portfolio of real estate projects at a rapid clip.
This expansion continued over the decades, as shown by Evergrande raising $722 million in its IPO on the Hong Kong Stock Exchange in 2009. The firm now controls 778 real estate projects in 223 Chinese cities, directly employing nearly 200,000 people. Evergrande has claimed that it has indirectly created more than three million jobs.
Huge debt pile
But at the beginning of the 2010s, in the wake of that blockbuster IPO, Evergrande stretched its tentacles into an array of other sectors. The company was in a “race against time to diversify its activities, much more so than other Chinese real estate groups”, Dufour said. The Communist Party had “made other sectors national priorities”, he continued.
Consequently, Evergrande acquired stakes in video streaming companies, health insurers, milk farmers and pig-breeding co-operatives. It also bought Guangzhou FC, a football club in the Guangdong region where it is based, and built amusement parks. Evergrande’s latest diversification project was an attempt in 2019 to start manufacturing electric cars – despite a lack of any experience in this field.
Evergrande got its fingers into so many pies because it wanted a presence in “a sufficient number of priority sectors so that the state would be more inclined to support it financially when the weight of its debt became too heavy to bear”, Dufour explained.
The debt is very heavy indeed. Evergrande is due to pay $15 billion to creditors by the end of 2021; but, as of late June, it had only $13 billion to its name. At the same time, the banks have become much more reluctant to lend it money. “It’s become more complicated because of the restrictive monetary policy the government is currently pursuing,” Rollin said.
Economic contagion risk
Evergrande has entered a downward spiral in which the banks no longer want to give it the funds to finish its real estate projects, depriving the company of new properties to sell and therefore of fresh funds to repay creditors and reassure the banks.
“In a normal market economy, Evergrande would have gone bankrupt a long time ago,” Dufour said. But the Chinese model of capitalism has long encouraged the model of private debt.
“The rule was that as long as a company looked like it was moving forward – with plenty of projects in the pipeline – the banks gave it credit on the understanding that the strength of Chinese economic growth would always deliver profits,” he continued.
This way of thinking meant that “in 2020, Chinese companies’ debt represented 160 percent of GDP, compared to just 85 percent in the US and 115 percent in the eurozone”, Rollin pointed out.
Companies like Evergrande find themselves in a tricky situation now that Beijing has pushed heavily indebted countries to deleverage over the past year.
But the Communist Party also faces a dilemma, as it needs to prevent Evergrande from going under, to avoid the “profound consequences it would have for the Chinese economy”, Dufour said.
If Evergrande went bankrupt, “at least one bank would go under”, Dufour continued. “That may well push other banks to be more reluctant to end to highly leveraged countries – and that would herald the end of China’s debt-fuelled growth model.”
The real estate behemoth’s collapse would sent shockwaves far beyond China. As the Financial Times noted: “Evergrande counts big international companies among its investors, including Allianz, Ashmore and BlackRock. A default is likely to have spillover effects on global markets, where many investors have historically anticipated Chinese government support at times of distress.”
Given Evergrande’s importance to the Chinese economy, “it’s highly probable that the state will sort out a debt restructuring programme for it”, Rollin said. In other words, Beijing will force creditors’ hands while organising the sale of Evergrande’s non-core assets.
“This will likely mean putting the company under the state’s control while it finds a buyer; an approach the Chinese government has adopted before,” Dufour said.
But cleaning up a mess as big as a $300 billion debt pile will not happen overnight.
This article was translated from the original in French.