Investors are preparing for the growing risk of Chinese real estate giant Evergrande collapsing under the weight of more than $ 300 billion in debt. But experts say the Chinese Communist Party will have no choice but to save such an iconic company from its economic growth model, and its collapse would cause shock waves to the world economy.
Western financial institutions think Evergrande has a bleak future, if at all.
JP Morgan drastically reduced the target price of its stock on Friday to 2.80 Hong Kong dollars from 7.20 Australian dollars.
This came after rating agency Fitch downgraded the company’s foreign currency credit rating from triple C to double C on Wednesday, saying a form of default “seems likely”. The rating agency Moody’s downgraded Evergrande’s credit rating for the third time in three months, citing that its creditors faced “weak prospects of recovery” if the company defaulted.
Evergrande is the most indebted real estate developer in the world; $ 300 billion is roughly equivalent to all of Portugal’s public debt. Not surprisingly, senior executives admitted in August that they may not be able 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 long-standing symbol of the country’s economically highly productive urbanization.
In addition, Evergrande’s business model is representative of China’s “highly debt-dependent growth model,” Jean-François Dufour, head of French-based DCA Chine-Analyze, a French-based consultancy, told FRANCE 24 .
The company was founded in 1996, in the Herculean effort of the Communist Party to move hundreds of millions of Chinese from the countryside to the cities, creating “strong growth in the Chinese real estate sector,” Frédéric Rollin, an investment told FRANCE 24 , strategy advisor to the multinational Pictet Asset Management.
Evergrande was the main beneficiary of this boom. It followed a very aggressive growth strategy and depended on the goodwill of the banks as it amassed a proliferating portfolio of real estate projects at a rapid pace.
This expansion continued over the decades, as demonstrated by Evergrande raising $ 722 million on its IPO in the Hong Kong Stock Exchange in 2009. The firm now controls 778 real estate projects in 223 Chinese cities, which give works directly with about 200,000 people. Evergrande has claimed to have indirectly created more than three million jobs.
Huge pile of debts
But in the early 2010s, following that superproductive IPO, Evergrande extended its tentacles to a number of other sectors. The company was in a “race against the clock to diversify its activities, much more than other Chinese real estate groups,” Dufour said. The Communist Party had “established the national priority of other sectors,” he continued.
As a result, Evergrande acquired stakes in video streaming companies, health insurers, dairy farmers and pig breeding cooperatives. He also bought Guangzhou FC, a football club in the Guangdong region where he is based, and built amusement parks. Evergrande’s latest diversification project was an attempt in 2019 to start making electric cars, despite the lack of experience in this field.
Evergrande got his fingers on so many cakes because he wanted a presence in “a sufficient number of priority sectors to make the state more inclined to give him financial support when the weight of his debt becomes too heavy to bear,” he explained. Dufour.
In fact, the debt is very heavy. Evergrande will have to pay $ 15 billion to creditors by the end of 2021; but by the end of June, it had only $ 13 billion. At the same time, banks have become much more reluctant to lend him money. “It has become more complicated because of the restrictive monetary policy that the government is currently pursuing,” Rollin said.
Risk of economic contagion
Evergrande has entered a downward spiral in which banks no longer want to give him the funds to finish his real estate projects, depriving the company of new properties to sell and therefore new funds to repay creditors and calm down. lize the banks.
“In a normal market economy, Evergrande would have failed a long time ago,” Dufour said. But the Chinese model of capitalism has long fostered the private debt model.
“The rule was that as long as a company seemed to move forward (with many projects underway), the banks gave it credit understanding that the strength of China’s economic growth would always produce profits,” he continued.
This way of thinking meant that “by 2020, the debt of Chinese companies accounted for 160 percent of GDP, compared to only 85 percent in the U.S. and 115 percent in the eurozone,” Rollin noted.
Companies like Evergrande are in a complicated situation now that Beijing has pushed heavily indebted countries into deleveraging over the past year.
But the Communist Party also faces a dilemma, as it must prevent Evergrande from being able to enter, to avoid the “profound consequences it would have for the Chinese economy,” Dufour said.
If Evergrande failed, “at least one bank would go under,” Dufour continued. “This may push other banks to be more reluctant to wipe out countries with high leverage, and this would herald the end of China’s debt-fueled growth model.”
The collapse of the real estate giant would cause shock waves far beyond China. As the Financial Times noted: “Evergrande has large international companies among its investors, including Allianz, Ashmore and BlackRock. A default is likely to have spill-over effects in global markets, where many investors have historically anticipated Chinese government support in times of difficulty. “
Given Evergrande’s importance to the Chinese economy, “it is very likely that the state will solve a debt restructuring program,” Rollin said. In other words, Beijing will force the hands of creditors as it organizes the sale of Evergrande’s non-core assets.
“This would probably mean putting the company under state control while it finds a buyer; an approach that the Chinese government has taken before, ”Dufour said.
But clearing a mess as big as a $ 300 billion debt pile won’t happen overnight.
This article was translated from the original into French.