[Q&A] What Exactly Is China Evergrande? ... Is the 2008 Global Financial Crisis Repeating?

[Image source=Reuters Yonhap News]

[Asia Economy Reporter Kim Suhwan] "Investors fear that the bankruptcy of China's Evergrande could lead to a repeat of the Lehman Brothers collapse that triggered the 2008 global financial crisis."

The Guardian recently reported the market sentiment regarding Evergrande Group (恒大·Evergrande), China's second-largest real estate developer, which is facing bankruptcy due to a severe liquidity crisis.

With debts amounting to around 350 trillion won, Evergrande has reportedly failed to properly pay even the interest on its bonds, raising the possibility of the largest default (debt default) case ever among Asian companies.

Concerns have emerged that the bankruptcy rumors surrounding Evergrande Group could lead to a downturn in China's real estate market, potentially resulting in consequences similar to the 'Lehman Brothers' bankruptcy that triggered the 2008 global financial crisis.

Q. What kind of company is Evergrande Group?

A. Evergrande Group is China's second-largest real estate developer, founded in 1997 by Chairman Xu Jiayin, who comes from a poor farming background in Henan Province. The company is listed on the Hong Kong Stock Exchange and headquartered in Shenzhen, Guangdong Province, China.

Chairman Xu Jiayin of China Evergrande Group
[Photo by Yonhap News]

Evergrande once held the position of the largest real estate company in China by asset size. Last year alone, it recorded sales of $78 billion (approximately 91 trillion won) and is conducting over 1,300 construction projects across more than 280 Chinese cities.

Evergrande Group has followed the typical business model of Korean real estate conglomerates from the 1980s, relying solely on borrowing to expand its business scale and using the funds raised to enter other business sectors, thus engaging in what is called an octopus-like expansion. It also pursued an aggressive business approach by leveraging close ties between business and politics to borrow large sums from banks to purchase vast amounts of land, on which numerous construction projects were carried out.

Evergrande expanded indiscriminately into other business areas such as electric vehicles (Evergrande Auto), football club management (Guangzhou FC), theme parks (Evergrande Children's World), film & TV drama production (Hengteng Network), food and beverage business (Evergrande Bingqian), insurance (Evergrande Life), and artificial intelligence & big data (Evergrande High-Tech), thereby growing its corporate scale.

As the company rapidly expanded, Evergrande Group now has nearly 2,000 subsidiaries within China alone.

Recently, it has been undertaking the 'Ocean Flower Island' project, an artificial island construction project worth 28 trillion won, building theme parks, shopping malls, museums, and more on the island.

[Image source=Reuters Yonhap News]

Q. Why is Evergrande Group facing a crisis?

A. Evergrande Group's octopus-like expansion drove rapid growth, but the problem is that most of it relied on borrowing, causing its debt to snowball.

On the 13th, before a protest by investors demanding bond interest payments in front of Evergrande's headquarters in Shenzhen, China, public security authorities deployed forces to control the area around the company. [Image source=Reuters Yonhap News]

Eventually, the debt grew to 350 trillion won, equivalent to 2% of China's Gross Domestic Product (GDP), earning Evergrande the dishonor of having the largest debt among real estate companies worldwide.

Especially, the outbreak of the COVID-19 pandemic last year pushed China's real estate market into a downturn, exacerbating Evergrande's liquidity crisis.

Additionally, the government implemented strict real estate loan regulations starting last year to deflate the real estate bubble, severely impacting Evergrande Group's borrowing-based management.

On the 13th, numerous investors gathered at Evergrande's headquarters in Shenzhen, China, staging protests demanding bond interest payments.
[Image source=Reuters Yonhap News]

As Evergrande was effectively blocked from borrowing and unable to manage its massive debt, it reached a point where it could not even pay bond interest.

On the 23rd (local time), Evergrande was supposed to pay $83.5 million (about 99.3 billion won) in dollar bond interest and 232 million yuan (about 42.5 billion won) in yuan bond interest to bondholders, but it reportedly failed to pay the interest on the dollar-denominated bonds.

As a result, with the inability to pay bond interest, Evergrande's bonds have effectively become 'worthless.' According to market research firm Refinitiv, as of the 24th, Evergrande's 5-year bond yield reached 546%.

On the 13th, investors flocked to Evergrande's headquarters in Shenzhen, China, demanding bond interest payments.
[Image source=Reuters Yonhap News]

Evergrande's stock price also plummeted 86% from its peak in January on the Hong Kong Stock Exchange. Along with this, The Guardian reported that due to massive debt, Evergrande is unable to pay salaries to its employees.

Q. Is the Chinese government taking action to resolve Evergrande's crisis?

A. Although there are calls for the Chinese government to intervene as Evergrande faces effective bankruptcy, foreign media report that authorities are currently willing to allow Evergrande's bankruptcy.

This is because the Chinese government prioritizes resolving the bubble economy and the massive debt problems of domestic companies, and there is insufficient justification to unconditionally bail out Evergrande Group.

Matt Bekink of the Economist Intelligence Unit (EIU) said, "China has been focusing on resolving corporate debt issues, and the current Evergrande crisis is a representative case."

[Image source=AP Yonhap News]

On the 23rd, the Wall Street Journal (WSJ) reported, "Chinese authorities have asked local governments to prepare for the possibility of Evergrande's default and its 'aftershocks,'" signaling that the government is reluctant to restructure Evergrande's debt.

This can be interpreted as the government being willing to accept Evergrande's default on the premise of minimizing its negative impact on the economy.

The WSJ further reported, "Local governments and state-owned enterprises have been instructed to intervene only at the last minute if Evergrande fails to handle matters orderly."

China's state-run Global Times also conveyed a message, quoting experts, that 'too big to fail' is not necessarily impossible.

However, some market observers speculate that authorities are considering separating Evergrande's core real estate business and turning it into a state-owned enterprise to control socio-economic fallout.

Hong Kong's Ming Pao, citing economic media Asia Markets on the 23rd, reported that Chinese authorities are considering splitting Evergrande into three entities, including the real estate sector, with an announcement possibly coming within days, and that the core real estate development sector would be converted into a state-owned enterprise.

[Image source=Reuters Yonhap News]

Q. Why are global stock markets falling due to the Evergrande crisis?

A. The bankruptcy of Evergrande Group inevitably has a significant impact on China's economy, the world's second-largest economic power.

In August, housing transactions in China fell 20% year-on-year. Also, China's manufacturing PMI for August, announced by the National Bureau of Statistics on the 31st of last month, recorded 50.1, down from 50.4 the previous month and marking the lowest level in 18 months since February last year’s 35.7.

[Image source=AP Yonhap News]

With signs of a slowdown in China's economic recovery appearing across the board, if a giant real estate company like Evergrande defaults, it could trigger a chain reaction throughout the economy.

In fact, if Evergrande goes bankrupt, it would deliver a significant shock to the real economy and could spread to the banking sector. According to the BBC, Evergrande currently owes money to 171 banks and 121 financial institutions within China.

Moreover, the potential mass bankruptcy of thousands of partner companies and job insecurity for hundreds of thousands of employees could also trigger a financial crisis.

Additionally, with Evergrande's dollar bonds amounting to $20 billion (about 24 trillion won), if it defaults, the losses for numerous foreign investors holding these bonds would inevitably snowball.

This spreading anxiety has negatively affected global stock markets. In fact, following the Evergrande bankruptcy rumors, on the 20th, the Dow Jones Industrial Average and the S&P 500 fell by 1.8%, while the VIX, known as the fear index, rose to 25.7, the highest level since May.

On the same day, Hong Kong's Hang Seng Index plunged 3.3%, Germany's DAX fell 2.3%, and France's CAC dropped 1.7%.

The WSJ analyzed that concerns over Evergrande's potential bankruptcy are impacting global markets, deepening the declines in New York stock markets.

Especially, news that Evergrande failed to pay dollar bond interest due on the 23rd weighed heavily on investor sentiment. If Evergrande fails to pay interest within the 30-day grace period, it could be treated as a default.

[Image source=AP Yonhap News]

Q. Will Evergrande trigger a repeat of the 2008 financial crisis?

A. Although market anxiety is spreading, experts assess that Evergrande Group's bankruptcy would differ somewhat from the 'Lehman Brothers' collapse that caused the 2008 global financial crisis.

The appearance of the Lehman Brothers headquarters

First, during the 2008 Lehman crisis, US mortgage-backed securities were sold to investors worldwide, and when the US real estate bubble burst, investors in other countries holding these securities were affected, triggering a global financial crisis.

However, in Evergrande's case, most investors holding its bonds are local Chinese, so the damage from its bankruptcy is expected to be less severe than the 2008 financial crisis.

Moreover, the Chinese government is aware of the potential economic crisis from Evergrande's bankruptcy and is expected to focus on minimizing the socio-economic fallout caused by Evergrande.

On the 20th, S&P stated in a report, "If the Evergrande crisis grows large enough to pose structural risks to the domestic economy, Chinese authorities are likely to intervene," and added, "Evergrande's bankruptcy will not lead to a 2008 financial crisis."

Nonetheless, since the real estate downturn leads to reduced consumption, Evergrande's bankruptcy could shrink Chinese demand for overseas products, services, and raw materials, potentially impacting global markets. Currently, China trades with over 100 countries, and US exports to China amounted to $124 billion (about 147 trillion won) last year.

[Image source=AP Yonhap News]

In fact, if the Evergrande crisis causes an economic downturn in China, there is a risk that the economic crisis could spread to other countries. Jimmy Chang, Chief Investment Officer (CIO) of Rockefeller Global Family, warned, "If China experiences serious economic problems due to Evergrande's bankruptcy, this will spill over into the global economy."