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How does Evergrande conglomerate put China's housing system in danger of collapse?

China’s Evergrande conglomerate is on the brink of defaulting on its $300bn in debt. A fire sale by the company could cause a real estate collapse in China.

China’s Evergrande conglomerate is on the brink of defaulting on its $300bn in debt. A fire sale by the company could cause a real estate collapse in China.

In a déjà vu of the 2008 collapse of US investment bank Lehman Brothers, Evergrande has overleveraged itself saddled with over $300 billion in liabilities and is blocked from borrowing to pay off debts. The massive conglomerate, one of the largest companies in the world, is rattling nerves in financial markets around the world considering the wider implications of its collapse.

Evergrande ran afoul of new regulations by the Chinese government to bring ever increasing housing prices under control leading to the company’s current credit crunch. Should the company experience a total meltdown it wouldn’t just cause housing prices to plummet in China but could affect other industries in the country and have rippling effects throughout the world economy.

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What is Evergrande?

Evergrande started out as a real estate developer in Guangzhou in 1996, at a time when China embarked on a project to promote private homeownership. It grew to prominence through massive borrowing to fuel its continuous expansion to become one of the largest companies in the world. The conglomerate has its tentacles spread far beyond real estate, controlling enterprises in several other sectors of the economy.

Beijing is not coming to the rescue

The company’s woes stem from reforms implemented by the Chinese government to create more affordable housing. The rise of Evergrande was built on property prices continually increasing but this has created a housing market that has become more difficult for ordinary Chinese to participate in.

The central government trying to limit financial risk introduced in 2018 regulations that would curtail how much a company could borrow as it became more indebted. This push to reduce debt to shore up financial stability is seen as a reason why Beijing will not step in to save Evergrande

"The government has worked tirelessly to drive de-leveraging in the bloated real estate sector, so throwing a lifeline to Evergrande now is unlikely," James Shi, distressed debt analyst at Reorg, told Reuters.

Collapse of Evergrande has wider implications

Markets around the world took a hit this week as investors worry about contagion from the demise of a company the size of Evergrande. The Chinese government will want to see an orderly dismantling of the company to avoid housing prices around China plummeting in the wake of an uncontrolled meltdown of the developer.

Should home values be lowered this could reduce Chinese consumer spending. Bill Bishop, author of the Sinocism newsletter told the Washington Post “People will feel poor. There is a chance that it could start somewhat of a prolonged slowdown.” This would have a knock-on effect in the global economy with demand dropping for products from other nations from luxury items to raw materials for domestic production.

The worries about the drag on housing values caused by Evergrande’s financial troubles is pulling down other Chinese real estate stock values. On Monday markets around the world tried to offload holdings of Chinese property companies resulting in a worldwide market dip.