Is Evergrande Too Big to Fail?



Backdrop
Imagine this, A real estate developer of the World's 2nd largest economy is under a debt of more than $300 billion, 1.6 million apartments are yet to be delivered, it owed its suppliers more than $100 billion. Horrified, isn't it? well, that's exactly what has happened in China. Evergrande the largest real estate developer is under humongous debt and is setting off a panic in the global market. Let's see why is that the case and will or rather should the Chinese government step in to bail Evergrande out.

What went wrong with Evergrande?
Evergrande is a real estate company and if it had limited itself to the property market there would have been not this much of a mess but the problem started when they ventured into Electric cars and a football team. Also bear in mind the real estate prices in China have been going up at an unreal rate the reason for which is the artificial scarcity of land. Real estate companies like Evergrande have access to cheap debt using which they buy Land from authorities creating an artificial shortage of land, ultimately explaining the rise in real estate prices. So yeah the fuss around this situation is similar to the Lehman brother's crisis of 2008 makes sense as both are results of years of mishandling the debt.

You see China has a three red lines policy, we won't go into the nitty-gritty of it, but in short, it is a policy that decides if a company is going overboard with debt, for each line crossed the company is asked to slow down the borrowing spree. The problem with Evergrande was it had crossed all the lines which meant all the funding taps for the company had been closed. So now you know what went wrong, let's see what can be its consequences.

The Effect
Many experts argue that the fall of Evergrande won't be as devastating as the Lehman Brother's fall of 2008, but it would be enough that its effect would be felt beyond the real estate market. Banks awaiting their loan repayment, suppliers expecting their payment, homebuyers are expecting their dream home will see the day of light. Experts also feel that Beijing has that political prowess and influence that it could stop this from turning into a catastrophe but it won't. Authorities want to teach real estate companies a lesson, to not go overboard on debt, especially not to foray into the unknown as done by Evergrande by foraying into Football club ownership and Electric cars. It is said that every one in five real estate developers in China has breached the three red lines policy. So the effect will definitely be far-reaching to other industries and maybe even to other neighboring countries.

Conclusion
The question that remains here is How badly do they want to teach someone a lesson and how willing are they to let other people suffer for that? because if this goes out of control it will not be good for the entire Chinese economy as it is a huge source of the country’s growth.

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Reference : Economic Times, Finshot.


Disclaimer

Above information is to spread financial literacy. We are not SEBI registered financial advisors, kindly consult your financial advisor before making any investment decision.

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