What is Evergrande issue and what it means for equity investors
When China's second-largest property developer is struggling with $300 billion in debt, it can snowball into a crisis
Evergrande development has been called as China’s Lehman moment by some. Stock markets have been worried and this ensured there was a broad sell-off in US stocks post the Evergrande news. What is Evergrande? Why should you care? Evergrande is a troubled Chinese property developer Evergrande. It has been hit with multiple ratings downgrade in as many days. But fortunately, Indian stocks have successfully shrugged off the Evergrande concerns so far. But anything can happen in future. Thus, it is important to understand the issue at hand for equity investors, irrespective of whether they have exposure to Chinese stocks or not.
World’s most indebted company
Evergrande is China’s second largest real estate company by sales. All was going fine, until Covid hit. As the company now struggles to repay creditors, global markets have responded with selloffs. To put things in perspective, Evergrande debt is now over $305 billion. And, it borrowed from everyone! Contagion fears have intensified as 128 banking institutions and 121 non-banking institutions are exposed to Evergrande.
Questions loom about a government bailout and whether Evergrande is in fact too big to fail. With the company warning investors that it could default on its debts, ratings agency Fitch has said that default ‘appears probable’ while Moody’s has said ‘Evergrande is out of cash and time’.
Apart from Covid and slowing real estate sales, do bear in mind that Evergrande fall-out is a result of growing government regulation in China’s property sector. The government there has been increasingly working to control surging home prices and excessive borrowing.
Evergrande is likely to default unless it successfully negotiates a restructuring plan with banks. The company has also been unable to repay investors in the wealth management business. This is why many have called Evergrande as China’s Lehman moment.
After a crash on Monday, most stock markets in the world such as Sensex and Nifty rebounded slightly on Tuesday. But worries remain about the impact the default would have on the global economy. Recall how IL&FS defaults shook the core of BFSI industry in India in 2018. Hence, stock markets around the world continue to keep a close watch on the Evergrande crisis, because such developments can spiral out of control at any time.
The truth is nobody really knows how the Evergrande and it’s 300 billion dollar debt mountain will play out.
In the event of a collapse, the Chinese economy and financial system will suffer a huge blow. Along with this, there will be a domino effect on several other domestic sectors and a spill-over effect on the global economy, especially financial institutions and businesses that are directly and indirectly linked to real estate and housing.
If you are wary of a risk-off situation, you should play it safe for a while. This means use asset allocation principles to decide exit and entries in equity, debt, gold, cash and mutual funds. Don’t try to venture out on adventures during the period when the Evergrande situation has no clarity.