You may have heard a lot on the news recently about Evergrande, the troubled Chinese real estate development company. Evergrande has accumulated roughly $300 billion in debt, mostly through borrowing to fund new construction projects.
Evergrande found itself in trouble after the Chinese government set limits in 2020 on real estate development borrowing. The purpose of the restrictions was to curb a steep debt-fueled rebound in the domestic real estate market following China’s first wave of COVID-19. New limits on borrowing and aggressive pre-sale practices that led to dozens of unfinished projects left Evergrande with more obligations than it could handle. A handful of banks started to refuse mortgages on the unfinished projects in July 2021 as the firm’s issues became more evident.
Now, more than $100 million in interest payments are coming due over the next few weeks, and the firm’s credit rating has been downgraded on the increasing possibility of default. This would limit Evergrande’s ability to borrow or refinance and increase its future borrowing costs, accelerating the challenges of an already-difficult situation.
Investors are most concerned about how Evergrande’s problems will be ultimately solved. The amount of debt the firm carries is unmanageable, but whether it declares bankruptcy, restructures, or gets a bailout from the Chinese government is still unknown.
Should You be Concerned About Global Fallout?
The situation doesn’t look to be globally problematic. Offshore investor exposure appears limited to Evergrande’s $18 billion in foreign-currency bonds, which is not significant enough to cause a global financial crisis.
For now, it appears that there will probably be an orderly restructuring of Evergrande’s debts and unfinished projects—not bankruptcy or a government-backed bailout. China’s state-run media have issued warnings to creditors who expect to be made whole that this likely won’t be the case, however. A restructuring will probably prioritize recompense for homebuyers; this means that there may be enough creditor losses to led some of Evergrande’s debts into default.
If this happens, only China’s system-wide bank reserves would be affected, and a restructuring with government support would ease at least some of creditors’ pain.
Will the Chinese Government Intervene?
Chinese President Xi Jinping will not likely sit idly by if broader panic starts to rise. Wide-ranging reforms that were passed in the summer have already pressured the country, and Xi can intervene if Evergrande appears to threaten Chinese financial markets. There’s already evidence that China’s central bank is positioned to offset tighter financial conditions. It started easing its Reserve Requirement Ratio in July when Evergrande’s problems first became apparent.
Aside from Evergrande’s problems, China’s struggles with the COVID-19 delta variant, technology crackdowns and the property sector may modestly dampen global growth. The sheer size of the Chinese real estate sector means that a reverse wealth effect on both the Chinese and global economies can’t be dismissed entirely.
Other Asian countries have benefited lately from improving vaccination rates and will need to pick up the slack. Despite these and other general worries about “peak growth,” many financial analysts view the outlook for global corporate earnings as solid.
Despite making headlines in the last few weeks, Evergrande is hardly the only concern on the financial horizon. There hasn’t been a significant stock-market selloff in a long time. It’s just as likely that the expected tapering of asset purchases by the Federal Reserve—and the possibility of rising inflation—could cause as meaningful a market pullback as debt troubles in Chinese real estate.