Debt defaults, bankruptcies, etc. were never sudden. They are less likely an accident than a long-term disease. Tumors, in their lifecycle, tend to be in the stealth mode going invisible undetected and thus untreated. By the time the symptoms explode the human body or maybe the real estate giant like Evergrande will be at the brink of collapse.
Six months ago, when Ever Given’s container ship got stuck in the Suez Canal clogging global energy markets and international trade, investors panicked. Today, markets are fretting over a potential default by Evergrande, a highly indebted Chinese real estate company that accounts for 2% of China’s total GDP.
Evergrande, a Chinese Real Estate company, was set up by Xu Jiayin (Hengda Group) in 1996. 2 years ago its market cap was more than $50 billion and today it was down to $4.9 billion. We can see a consistent decline in revenue from 59% in 2016 to 6% in 2020. There was a fallout in the margins too. The slump in gross profit rate was mainly due to reduced selling prices as a result of the COVID-19 Pandemic. The margins were cut in half. This collapse was driven by a reduced gross profit margin and an increase in selling and marketing expenses.
A negative Cash flow from operations is seen which is a clear indication that no money is generated from its operations. An erratic CFO means that the firm may be at the mercy of lenders just to fund its operations.
Evergrande’s massive debt problems have ripped out into global markets with big swings. This huge China’s property developer is faced with $300 billion in debt with hundreds of unfinished projects and unhappy suppliers. The company started to pay overdue bills by handling unfinished properties with a discount of 52%. Now Evergrande is seen as a threat to many Chinese banks and institutions as 171 Chinese banks and 121 financial institutions who have lent money to Evargrande are in trouble.
In its glory days, Evergrande expanded its business from real estate to electric vehicles, sports, and theme parks. Xu Jiayin being a member of the Chinese People’s Political Consultative Conference gave creditors the confidence to lend money for the expansion of Evergrande’s businesses leading to more debt than it could pay off. This huge collapse of the giant real estate company will affect the entire economy by dragging down growth and by setting up a cascading impact that affects the global commodities and financial institutions. As many banks and financial institutions were troubled, this default could lead to a credit crunch. This can be a serious issue as companies that cannot borrow will find it difficult to grow and in some cases, they will be unable to continue their operations.
Shares in Evergrande, the world’s most indebted company tumbled down to less than 85% and its bonds got de-rated. Beyond the potential default, international investors are worried about what may happen next as a big chunk of China's economy is linked to real estate. The company broke its silence and revealed that it will be selling 50.01% of the property service division to Hopson development.
Xi Jinping’s effort to return to socialism:
China imposed the three red lines guidance on selected developers after an August 2020 meeting in Beijing that occurred against a backdrop of growing debt levels, rising land prices, and booming sales.
The three red lines
1. Liability to asset ratio (excl. advance receipts) of less than 70%
2. Net gearing ratio of less than 100%
3. Cash to short-term debt ratio of more than 1x
If the developers fail to meet one, two, or all of the ‘three red lines’, regulators would then place limits on the extent to which they can grow the debt. China’s authorities created a colour code scheme to simplify the implications of the policies, which breaks down as follows:
Impact On India:
China plays a key role in global commodity prices including metals. As the Country’s real estate sector was impacted and the real estate sector is a major consumer of steel leading to reduced demand and stumbling steel prices. Some of the Indian steel companies had been on a downward trend and their share prices were reduced up to 2%.
If China Faces this economic slowdown commodity-exporting companies in India will face the axe. We will incur intense competition from Chinese companies if the Yuan depreciates during this slowdown. This will lead to severe intense competition between the export companies of India and China.
However, a fraction of the market also believes that this Evergrande crisis might create a positive impact on India in the long term. Considering the Trump-Xi War and Covid-19 pandemic, it has triggered global companies to look for other alternatives to China. This benefits India in many ways and will continue to do so in the near future. As of now, India might be witnessing funds outflow, but in the long-term, as global manufacturers are looking for other alternatives, India will be the better option.
Official Promotional Partner
Official Coverage Partner
Well written!