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What property developer Evergrande’s debt crunch could mean for U.S. businesses

Posted by Kanika Sinha

October 11, 2021    |     4-minute read (731 words)

Snowed under by crushing debt of more than $300 billion, Chinese real estate behemoth Evergrande is on the brink of collapse. Starved for cash, the property developer is struggling to pay suppliers and even asked employees to lend it money.

Analysts fear the potential fallout could turn into China's Lehman Brothers moment and warn the contagion could have far-reaching implications that spill beyond China’s borders. The stock markets of all major economies have already recorded worrying signs in recent weeks. 

The Evergrande empire

Shenzhen-based Evergrande is one of China's largest property developers. The company was featured on Fortune’s Global 500 list, meaning that it's also one of the world's biggest businesses by revenue.

Founded by billionaire Xu Jiayin in 1996, Evergrande rapidly expanded during China’s housing boom, buying land and delivering over 1,300 projects in more than 280 cities across the country.

Beyond housing, the company has also invested in electric vehicles, theme parks, food and beverage businesses, bottled water and even owns a soccer team. According to Evergrande’s website, the company employs 200,000 people and is indirectly responsible for an estimated 3.8 million jobs each year.

What is the crisis?

The Evergrande crisis was precipitated by the Chinese government’s “three red lines” policies in the property sector that cap borrowings of companies.

As Evergrande breached all three red lines, regulators placed a very hard cap on its debt — the primary way the company created liquidity.

To counter that, the developer tried selling off some of its business. But a progressive slowing down of the property market in China and tapering demand for new houses crimped Evergrande’s cash flow, forcing it to suspend construction of apartment buildings and delay payments to suppliers.

Losing nearly 90% of its value, the company is now struggling under a crushing $300+ billion liabilities burden that has decimated its credit rating and share price. It is faced with about 800 unfinished residential buildings, many unpaid suppliers and over 1 million homebuyers who have partially paid for their properties. 

Implications for the U.S. economy 

The possible collapse of Evergrande will have a profound impact on the Chinese economy and is also likely to have a serious knock-on effect on the global economy. 

In fact, the looming crisis is already punishing global stocks. The S&P 500 fell 5.2% from Sept. 2 to 20, and the VIX, an index that measures S&P volatility, hit its highest jump since May 2021. 

Initially, some economists opined the U.S. would largely be shielded from major disruptions from the Evergrande’s debt crisis. They expected a decline in the $120 billion worth of exports to China every year as the biggest risk to the U.S.

However, U.S. Secretary of State Antony Blinken recently warned of the profound ramifications of the collapse for the entire world and issued a direct plea to China to act responsibly. “ So certainly when it comes to something that could have a major impact on the Chinese economy, we look to China to act with – to act responsibly and to deal effectively with any challenges,” he said in his October 6 interview with Bloomberg Television.

Blinken’s alarming assessment of the Evergrande fiasco immediately sent shock waves through the finance world. Contained with fears of a domino effect, the markets are now looking to the Chinese government to stem the Evergrande panic.

Lessons from Evergrande debt story

As housing prices continue to surge in other regions, the world can learn from the Evergrande crisis and past housing bubbles to prevent future crises. Here are some lessons: 

Robust and timely market data delivery: Regulatory authorities need to work with the real estate industry to provide robust market data and analysis, including statistics related to the financing of industry investment and development.

Consider external policy impacts: The real estate industry must engage with governments and policymakers at all levels, local, national and global, on the impacts of public policies on the real estate sector.

Establish information clearing hub: An information hub should be established to track and communicate new policies and research to decision-makers in the real estate, banking and finance sectors to help them address any adverse developments.

Embrace transparency and understanding: National and international authorities should adopt enhanced transparency and understanding across real estate and related markets for securities and derivatives.

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