The IL&FS crisis happened in India in 2018 following a liquidity crunch. The same is happening in China, where the biggest real estate developer, Evergrande, is staring at the brink of bankruptcy. Evergrande is said to have debts of about 2% of China’s whole GDP. This means if it goes down, it’s going to take the world down.
How Did This Happen In The First Place?
Founded in 1996, Evergrande is the top-most real estate borrower in China. The two biggest problems that took place was that Evergrande built its business on the back of high debts, and regulators in China did not look into it.
There are more shocks coming up in this article. Apparently, 128 banks and 121 non-banking companies have lent money to Evergrande, which means that the banking sector is going to spiral down. Furthermore, 1.6 million properties have not been sold to the home buyers, which has resulted in an 80% fall in the share price of Evergrande this year.
How Big of A Problem Is It?
The Chinese property sector is also reliable on offshore financing i.e. offshore bonds. Now, Evergrande’s total liability stands at $313 billion, which is roughly 6.5% of the total liability of China's real estate. Out of Evergrande’s total liability, offshore bonds account for $1.9 billion, which is 9% of the offshore bond market. This means that when Evergrande defaults, the bond market is in great danger. This will send tremors to the United States and countries all over the world.
Probable Outcomes
The credit event of Evergrande seems unavoidable. In this case, there are two things that can happen now - restructure or liquidate. Since there is a cash crunch already, the restructuring process looks like what will happen now. Restructuring will give a cushion to the bonds. However, liquidation could create a high degree of negative response from the investors and the lenders. Decline in investors' confidence could cause material loss to overall emerging markets. Broad-based indices are already feeling the ripples from this liquidity freeze. This could heavily impact other countries, especially India. Meanwhile, banks and non-banks with large exposures to Evergrande will negatively impact the credit/equity markets.
Evergrande’s Current Plan of Action
One of the lenders has already made provisions for losses for some portion of the entire loan. Meanwhile other creditors to Evergrande are planning to give some more time to the batting developer. Media reports have said that the government's direct bailout is unlikely. The company and its lenders will have to figure out. Policy makers in China have asked lenders to extend interest payments or rollover loans to Evergrande.
Road Ahead…
The situation is expected to remain precarious in the near future. Association of India buying and selling goods with China will impact the indices here. Sensex and Nifty will also be affected by what's happening in the bond market. Panic selling is already being witnessed as market watchers fear of a potential collapse of the Chinese real estate market. Meanwhile, Evergrande’s chairman has confidently made a statement that the company will walk out of its darkest moment. And this only time will tell.
