Bijetri Roy, Managing Director & Chief Strategy Officer, InsPIRE
Crisis ridden Evergrande is one of China’s largest real estate developers and is also the most indebted. The crisis has raised alarm bells across the globe. Financial Times has reported that the company used billions of dollars raised by selling wealth management products to retail investors to plug funding gaps and even to pay back other wealth management investors. It is also reported that Evergrande financial advisers marketed the products widely, including to homeowners in its apartment blocks, while its managers persuaded subordinates to invest.
Evergrande owes money to thousands of retail investors along with banks, suppliers and foreign investors, who fear they will not be repaid if the property group collapses. The Rmb 40 billion of wealth management products of Evergrande is dwarfed by its total of liabilities of Rmb2 trillion (USD 310 billion) (Source: Financial Times).
Evergrande’s total debt exposure (USD 310 billion) includes USD19 billion in offshore dollar-denominated bonds. The group has expressed that it might default on USD 80 million worth of interest payments due within a week. This would not only have ripple effects within China but the global economy as well. There are 128 banks and about as many financial institutions have direct exposure to Evergrande. A large number of these institutions could take big hits if the company collapses, sending shock waves across global markets. A tightening of controls by the People’s Bank of China and a weakening of housing demand has resulted in this crisis.
There is a view among a section of experts that the crisis is reminiscent of the Lehman crisis of the US in 2008, which triggered the Global Financial Crisis. However, a contrarian viewpoint is gaining support. According to a team at Barclays led by Ajay Rajadhyaksha, the two crises could not be more different. They argued: “the property sectors’ linkages to the financial system are not on the same scale as a large investment bank, but the debt capital markets are not the only, or even the primary, means of funding. China is to a large extent, a command-and-control economy. In an extreme scenario, even if the capital markets are shut to all Chinese property firms, regulators could direct banks to lend to such firms, keeping them afloat and providing time for an extended ‘work-out’ if needed.
The only way to get a widespread lenders’ strike in a strategically important part of the economy would be if there were a policy mistake, where the authorities allow the chips to fall where they may (perhaps to impose market discipline), regardless of the systemic implications. And we think that’s very unlikely; the lesson from Lehman was that moral hazard needs to take a back seat to systemic risk. We don’t mean to imply that China has succeeded in suspending the laws of economics. If an asset can’t fully service the underlying debt, it of course matters. But the economics can show up through either a one-time (violent) balance sheet adjustment – aka a financial crisis – or through many quarters of income statements (a debt bubble being deflated).
We also don’t mean to suggest that China could never have a Lehman moment. But with the banking system likely to be pressed into service as a funding source in the event of real stress, China would likely face a ‘true’ financial crisis only if its banks had funding problems. This risk was high in 2015, when the country saw over a trillion dollars of capital flight, meaning there was something of a ‘run’ on the domestic financial markets as a whole”. (Source: Financial Times).