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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.
- 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.
- 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 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.
- 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)