Accelerating Fallout from the Evergrande Collapse

And, now for some more bad strata news from China ...

The Chinese property developer, Evergrande Group, is heading for one or another kind of collapse with uncertain international and Australian impacts. So, what’s the latest news on this story, and what do real experts say about it …

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Introduction

I didn’t think that my short article about the demolition of some defective strata buildings in Kunming, China would become the start of a bigger story about a property developer collapse with international impacts that might even affect the Australian economy and strata development sector.

But, that seems to be where the Evergrande Group story is heading.

I’ve written a little about the Evergrande Group in the following articles:

• A Chinese Solution for Defective Apartment Buildings: Or, what getting tough on strata builders & developers really looks like ...

• Chinese Property Developers Crashing [not cashing] Out: How problems in the Chinese apartment market cause ripple effects ...

But now, some real experts at The Conversation, are also writing about the potential impacts of the Evergrande Group collapse in this scholarly article ‘3 ways the collapse of Evergrande will hurt the Australian economy’ by Professor Robert Powell of Edith Cowan University.

The Evergrande Group story so far

Evergrande was a symbol of China’s debt-fueled approach to growth, taking on massive debt (now $300 billion by some estimates), and applying the funds to extensive real estate development across virtually every Chinese province.

This suited China’s economy and its government well. Real estate investment was a bulwark of their economy, helping to maintain growth even when other sectors floundered. Local government officials were also happy to sell land to developers like Evergande, thereby expanding government revenue at the local level and adding to local economies.

But, things changed as a result of the following converging problems for Evergrande [and lots more]:

• the Chinese government became increasingly concerned about the level of debt linked to the country's real estate market, and introduced new policies in 2020 to reduce it,

• the inability to increase debt detrimentally affected Evergrande’s cash flow, its ability to service debt, and, to meet creditor payments,

• Evergrande started selling apartments at discounts to bolster its cash flow,

• an oversupply of empty apartments in many parts of China reduced the effectiveness of Evergrande’s sell-down strategy,

• Evergrande owed money to about 171 Chinese banks and 121 other international financial firms,

• Evergrande faced recurring problems meeting bond payments when due,

• problems started to emerge with Evergrande’s ability to finish building an estimated 1.4 million apartments it had sold to off-the-plan buyers,

• their share price dropped by 80% in 2021, and

• major shareholders [like its second-largest, Estate Holdings] began pulling out and abandoning tens of millions in stock.

You get the picture.

Whilst some analysts believe Evergrande won’t collapse completely, there will be significant losses even if it manages to stave off a full-fledged default, and, Evergrande’s future is hardly secure.

At the same time, another large Chinese property developer, Fantasia, has also missed a bond payment as the ABC News reports in ‘Chinese developer Fantasia misses bond payment as Evergrande teeters on collapse’, suggesting the problems are bigger than just one over-leveraged company.

What Professor Powells says

In The Conversation article, Professor Powell says that there are 3 potential impacts on Australia from the Evergande crisis as follows.

1. There is likely to be a significant reduction in Chinese property development with consequent drops in demand for raw materials including steel [which is made from iron ore].

Since 60% of the iron ore imported by China comes from Australia and it is our most valuable export, any drop in demand will have a double whammy effect here:

• reducing total sales and revenues, and

• causing global iron ore price drops.

This will hurt the Australian economy.

2. The problems in China’s real estate and financial sectors could ripple across China’s economy, hurting Chinese demand for other goods and services from Australia.

You may not know, but China is Australia’s biggest export market and Australian exports to China is three times more valuable than to our second biggest market, Japan.

Whilst, it’s possible we can sell those exports to other markets, there will still be severe short-term impacts whilst those markets develop.

3. Just the collapse of Lehman Brothers in 2008, triggered more financial collapses and the Global Financial Crisis, there could be a knock-on effect on other major businesses in the same or related sectors around the world.

That’s especially if they perceive this as the beginning of a new approach by the Chinese government towards its mega-corporations, which it probably is.

As Professor Powell describes the phenomenon, it’s like a contagion that spooks markets and credit markets who become nervous and perpetuate and magnify the effects.

Conclusions

Whilst there’s plenty of rhetoric in Australia about us getting tough on China and reducing our dependence on it, the reality is that we’re connected to China in significant ways and cannot avoid major economic and political events that happen there.

October 07, 2021

Francesco …