How China’s Evergrande Could Create a Major Crisis?

Evergrande of China is in the news for all the wrong reasons. It is no ordinary company. It is the second largest Chinese real estate company and has been a big beneficiary of the real estate boom across China. With over 1,300 projects spread across 280 Chinese cities, Evergrande borrowed heavily to finance its growth. Today, Evergrande stands with insufficient cash to repay $305 billion in debt.

The problems for Evergrande came as it borrowed more aggressively to finance its projects. It sold properties with lower margins to raise enough cash to fund its next project. The problems just aggravated when the Chinese government tightened debt limits on companies. The first indications of trouble were visible when the stock price of Evergrande fell 80% and its bonds crashed 30% in a day before trading was frozen.

Obviously, a company as large as Evergrande is likely to have a ripple effect. A whole range of stakeholders including banks, suppliers, home buyers, investors, trusts and mutual funds are going to feel the heat if Evergrande files for bankruptcy. It is estimated that 128 banks and 121 shadow banks are exposed to Evergrande in some form. The impact could surely be far reaching; and experts are calling it China’s Lehman moment.

The good news is that Evergrande may not be as bad as Lehman. Firstly, Evergrande is a real estate company and not a bank, hence systemic risks are limited. Secondly, the Chinese government has already committed a $14 billion bailout package for Evergrande and has the muscle to bankroll a bigger bailout. Also, the international implications of Evergrande are not as serious as Lehman.

There are 2 key risks for India. Firstly, if this leads to a hard landing for China, the demand for a whole lot of commodities could suddenly evaporate. That is not great news for commodity stocks in India. Secondly, if China hard lands, the Yuan could weaken, pulling the rupee down to remain competitive. That is a worry for FPI flows into India.