Context
The financial system is highly interconnected, meaning a minor crack anywhere leads to spillover effects all across the globe.
This was well captured in the Global Financial Crisis of 2008 when the major financial institution of the US, Lehman Brothers’ default led to total chaos in the global economy.
History repeats itself and is repeating in China as we speak.
Evergrande enters the picture
Evergrande is the biggest real estate developer in China and also the most leveraged globally. The real estate industry prospers at the cost of a continuous flow of debt.
Why you may ask?
Construction takes a lot of money and time, so the property maker has to tie tons of money in equipment, inventory, etc.
Simply put, the cash outflows are more than the inflows. Whereas inflows are limited to a small upfront deposit made by the buyers.
The cash conversion cycle is more, hence to keep things running, developers go for debt.
All bad things you can imagine!
Debt is a two-edged sword that amplifies the good times and the bad times, Evergrande seems to be on the other side. The company was already suffering from poor sales, a slowing economy, and a cash crunch.
To aggravate things more, the management burnt cash in all ways possible, be it a football club, streaming media company, an amusement park, etc.
It’s quite obvious when the sales are not kicking in, there’s absolutely no way to pay the interest cost. Hence, things started deteriorating for Evergrande!
More loans to repay loans!
The management resorted to anything and everything in sight, it took more leverage (debt) to repay existing debt, but that move proved to be counterproductive.
Plus, it asked its employees to lend them loans or be deprived of the yearly bonus.
Unfortunately, none of that worked. Come Thursday, the interest payment worth $83.5 Million on Chinese bonds & $36 Million on offshore bonds will be due. If the company is not able to pay it within the subsequent 30 days, it will default!
In the next year, payments worth $7.4 Billion will be due. Long story short, things cannot be worse!
Xi’s response?
There are protests happening by the buyers who have made the deposit for the houses that were never built, and the lenders who’ve lent tens of billions of dollars are on the edge.
Meanwhile, the Govt has avoided the issue. There’s no action from the CCP & that’s causing even more panic amongst the public.
The Govt is also in a tough dilemma, whether to bail out & let all the issues slip away or avoid the situation that will eventually destabilize the economy!
Markets react
The investors & traders alike are worrying that after gaming, online education, casinos, the real estate market will be the latest to come under the Govt’s radar for a crackdown, owing to that worry, the financial markets all across the globe are falling precipitously.
What do you think, what’s the way forward for Evergrande & the broader Chinese economy?