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Will Evergrande Debt Crisis end China’s miraculous economic growth?

Will Evergrande Debt Crisis end China’s miraculous economic growth?

Relevance:

  • GS 3 || Economy || External Sector || International Tax Issues

Why in news?

The financial crisis at China Evergrande Group, the world’s most indebted property developer, shed new light on the condition of China’s real estate industry.

Present Context:

  • China contributes more to global economic growth than any other country.
  • It is the largest contributor to fluctuations in global demand and trade in practically all commodities because it is the world’s manufacturing powerhouse and leading trading nation.
  • China is predicted to account for over a third of global growth this year. As a result of all of this, the globe will slow down if China does.
  • Prices for everything from oil to steel will decrease if Chinese demand falls. The effects will be felt across the board, notably in the financial sector.

Evergrande:

  • The crisis involving China’s largest housing company, Evergrande, which is owned by a guy who was once China’s wealthiest individual, has caused market jitters around the world.
  • Evergrande controls two-thirds of an electric vehicle company that was valued greater than Ford Motors before it produced even one vehicle.
  • Evergrande has failed to pay employee salaries and vendor bills. The sale of new apartments has been prohibited by several municipal governments.
  • If the company goes bankrupt, it will have ramifications for other Chinese housing enterprises, raising the risk premium on emerging market bonds.
  • If finance becomes scarce, even otherwise successful Chinese businesses may find themselves unable to maintain operations.

China may save it:

  • However, when viewed in the context of the Chinese economy, this appears to be a minor issue that can be resolved rather easily.
  • Evergrande’s $300 billion debt is less than 1% of overall Chinese debt.
  • The Chinese government can restructure the company, sell other businesses (such as the electric vehicle company), and so on.
  • Evidence of government support can calm markets and limit the negative consequences.

What are the real issues?

  • Evergrande is in difficulty because it is part of a much wider problem that prompted Beijing to tighten down on excessive debt last year, particularly in housing industries but not exclusively.
  • China’s debt is commonly recognized to be dangerously large, at roughly three times its GDP, with the ratio virtually doubling in recent years.
  • Evergrande faced increased borrowing constraints as a result of the tougher credit standards introduced last year.
  • Beijing then shown its seriousness by allowing a few businesses to fail.
  • If it now bails out Evergrande, it will set a precedent for other enterprises, defeating the aim of the financial squeeze.
  • Beijing’s perspective of financial contagion and systemic danger will determine the path of events.

Will It Impact China’s Growth:

  • Because the majority of Evergrande’s debt is local, the worldwide financial repercussions of its bankruptcy may be modest. There will, however, be second-round consequences.
  • More crucially, if the free flow of credit has aided China’s rapid expansion, particularly following the global financial crisis of 2008.
  • Tighter credit standards will have an impact on the speed of Chinese economic activity, and thus the world economy.

Why is the company in trouble?

  • The property sector accounts for nearly a third of Chinese GDP, with Chinese authorities traditionally encouraging businesses to take on massive debts.
  • However, the recent Chinese government’s rules for property developers, known as the “three red lines,” specify how much a property developer can borrow based on its financial situation as measured by three debt metrics.
  • Evergrande was effectively barred from taking on any more debt as a result of this strategy.
  • According to several analysts, the company’s business model has been unsustainable for quite some time.
  • It was claimed that the corporation kept properties it couldn’t sell as inventory on its financial sheet to avoid recording losses.
  • The company was also accused of conducting a ponzi scheme since it required a steady infusion of capital to support a fundamentally unsustainable economic model.
  • The Evergrande problem has been dubbed by many. China’s own “Lehman Brothers moment,” in which the fall of the American bank Lehman Brothers triggered the 2008 financial crisis.

India’s Reaction:

  • India’s brisk iron ore exports, much of which is destined for China, could be harmed if China’s twin crises result in a prolonged downturn in the country’s real estate sector.
  • Furthermore, there could have a long-term impact on global growth expectations, harmeding the economic recovery in markets like India.

Way forward:

  • Any bailout by the Chinese government will need the production of new money, lowering the value of the Chinese currency. Foreign investors with Evergrande exposure may suffer losses.
  • Any downturn in China’s economy as it transitions away from the property sector will have ramifications for the global supply chain. For example, metal stocks in India have experienced a steep drop due to expectations of a drop in Chinese demand.
  • Some critics have warned investors against investing in China, citing the country’s lack of rule of law.
  • Some analysts anticipate China’s growth rate could fall to as low as 1-2 percent as it rebalances its economy.

Mains oriented question:

Is there a systemic danger associated with the Evergrande crisis? How China will response to it? Does it have any impact on India? (200 words)