Financial news these days is filled with stories of the imminent demise of Evergrande the second-largest real estate developer in China. A very large conglomerate with diverse business interests like mineral water, pig farming & owning a soccer team.
Real Estate forms 29% of the GDP of China. The massive boom in China has been fueled by construction, construction, and more construction. Residential, Commercial, Bridges what have you.. Massive leverage with the blessings of the government inflated the Chinese property bubble & how.
Evergrande, once the most valuable real estate company in the world has amassed $300 billion of debt which it is finding it difficult to service. It is cash-starved and is likely to default on its obligation which has made the whole world nervous.
If a gigantic company like Evergrande fails and collapses it will inevitably crush many many others underfoot for little fault of their own. Also, the ripple effect will be felt all over the world. Fortunately, there is hope as analysts view is that there aren’t many foreign lenders to Evergrande which will cause a contagion default like Lehmann & the Great financial crisis of 2008.
The Chinese government has aped the west to grow via amassing a huge amount of debt. The policymakers did whatever was required to grow and create a modern, prosperous, technologically superior China. The goals have been achieved without any doubt. The time has come to pay the price for the stupendous growth.
The difference between Lehmann & Evergrande is that no one saw the collapse of the mortgage-backed securities market and Lehmann’s demise coming. Whereas Evergrande is sort of deliberately strangled by the authorities by squeezing their credit lines. Analysts have described this as a planned controlled demolition of the real estate industry.
There have been talks of a massive property bubble in China for years, hushed whispers of ghost towns in many provinces, and massive unused inventories. Reports suggest that China has vacant property close to 90 million. Enough to house entire countries like Canada, France, or Germany.
If there is massive deleveraging by China, there is bound to be an impact all over the world. In the past, China had always bailed out or supported these companies whenever there was some sign of trouble. The CEOs were charismatic, powerful, and had the full backing of the government. This led to blind faith and disregard for the massive debt piles as there was the well-founded view that these companies will not be allowed to fail.
But now the story has changed. Henceforth, the headmaster wants different results from his wards. They want sustainable growth even if it means slowing down the juggernaut.
The Chinese president Xi Xinping has squeezed out the benefits of the capitalist philosophy and now wants to redirect the country to a socialistic structure. They want to address the inequality in income and has clampdown on what it perceives as excesses of capitalist societies. The tech sector, wealthy tycoons, the for-profit education sector, the video gaming industry have all incurred the wrath of Beijing and are being systematically squashed.
The moot point for us is why should we care what happens to our giant neighbour? The world is interconnected, if there is a slowdown in China, it may slow the world and us down. It may impact our exports, may disrupt the supply chain, impact commodity prices.
Foreign Portfolio investors may get disenchanted by emerging markets and may start fleeing, which does not bode well for India. Or it may perceive India as a more stable democracy where such highhandedness of the government may not be tolerated and increase allocation here. A Chinese supply chain dislocation may provide us an opportunity to fill some gaps in demand unfilled by them.
Markets are justifiably nervous as there is uncertainty and this may be the trigger that topples the runaway market down.
We have to pay attention to how China manages and contains Evergrande and moves to a more socialist construct. They probably have a grand plan in place.
In the next few days and months, the supreme powers in Beijing may redirect their countries with the economic constraints they have to deal with. The people of China have also tasted prosperity and western type entrepreneurial freedom. Will they passively accept the old authoritarian ways passively?
As the old Chinese curse has said “May you live in interesting times.” We do live in interesting times..
Vishal Waghate
Very much informative! đź‘Ť
Amita
Many thanks.
Reema
Superb article. I believe India will most certainly benefit. Thanks for a great read, as always!!