China's Next Challenge

Ernst Hemingway once wrote that bankruptcies happen gradually, and then suddenly.

Such words seem fitting to describe the inevitable fate of Evergrande, China’s second biggest property developer by sales, and now the world’s most indebted company.

The crisis, precipitated by Chinese President Xi Jinping in his attempts to reduce the amount of debt in the Chinese economy, came to full fruition on September 23rd when the company defaulted on a deadline for paying $83.5 Million USD in interest on a dollar bond.

In the last year, Beijing has taken significant steps to improve financial health in the real estate sector, with the country introducing the three red lines policy in attempts to force deleveraging, and which has severely limited the capacity for many real estate firms to borrow. Although, this has not gone as smoothly as possible, with both Evergrande, and now Fantasia Holdings defaulting on dollar-bond debt.

The consequences of this are significant, with the Real Estate and Construction industries accounting to 29% of Chinese GDP (Kenneth S. Rogoff and Yuanchen Yang), both changes in Beijing’s approach to the management of the Chinese economy, and the potential collapse of Evergrande are likely to have significant effects both on China’s GDP and the global financial markets.

The immediate impact of Evergrande’s troubles will be on China’s once booming property market. It is a market which has been over-expanding for many years. If Evergrande were to collapse, it would cause a domino effect across the sector, potentially leading to the demise of more businesses. Indeed, the China Chenxin Credit Rating Group (CCXIS) has already downgraded the outlook of China’s property sector to negative.

In addition to this, beyond the world of property, the collapse of Evergrande would have major ramifications in other sectors it is involved with, including consumer electronics, building materials, furniture, and electric cars, and with 27% of the countries banking assets tied to real estate, the risks to the banking sector are unprecedented.

In the immediate future, the Chinese government must weigh up if they deem Evergrande “too big to fail”, and with this Beijing face one of their biggest dilemmas. Step in and bail Evergrande out, but send the message to other heavily indebted developers that they can expect the same treatment, or allow the company to collapse and risk both the fallout to other sectors of the economy, and the anger of the Chinese people.

The world watches on in anticipation.