Is Evergrande leading China's economy towards a crash?

The 2008 housing bubble burst in the US caused a major recession that affected not only the US but the entire world. At the center of the recession was a major US bank - Lehman Brothers, a bank that was considered too big to fail.

A story somewhat similar is now playing out in China. A Chinese real-estate company called Evergrande is currently sitting on a $300 billion debt for which it doesn't seem to have the capital to re-pay.

More on Evergrande:

Evergrande owns more than 1300 building projects in over 280 cities across China. That's a huge number of projects. The company also dabbles with investing in startups, owning a football team in China amongst other things.

But how did it reach this position and why isn't it able to pay off the debt if it's such a huge company?

The company kept taking debt in the name of expansion as it saw housing prices rise. The government introduced new laws limiting the amount of debt real-estate companies could take based on their current financial health and since Evergrande could not take up any more loans and had a lot of its capital already invested in projects, it is now stuck in this position.

But why is it being compared to the 2008 financial crisis where a major bank failed?

Even though Evergrande is a real-estate company as compared to Lehman Brothers, which was a financial institution, the company has taken loans from more than 170 domestic banks and if it defaults on these loans, it can cause a major credit crisis in the country and can cause a major hit to the Chinese economy.

Does that mean we're about to see another 2008 crisis?

The likelihood of that seems low. There are two reasons for that:

1. Markets don't like uncertainties. The first time a company that big crashed was in 2008. People did not know what was going to happen, thus causing fear, which led to people pulling out their money and causing the market to crash. At this point even if Evergrande collapses, China already has a roadmap on how the US handled a similar crisis in 2008 and how to bring the country out of such a situation. This instills stability and boosts confidence. Hence, though we might see short-term dips in the market, chances of a full-scale recession similar to that of 2008 seem bleak.
2. During the 2008 crisis, there was a lot of dependence on US markets for economic stability. Today, especially after the covid crisis, a lot of countries in 2020 decided to find alternate sources for trade and manufacturing to reduce their dependence on China. Hence even if there is a hit to the Chinese economy, other countries today are better positioned than they were before covid to tackle this situation.

Can the government intervene?

Real-estate business requires a lot of capital up-front. Hence most of the real-estate companies are debt-ridden and with the housing market in China contracting, government intervention to bail out Evergrande creates a perception that the government would bail major companies out if they reach a similar situation. This is just the financial aspect. There are political aspects involved too. Apart from criticism from the opposition, it'll also look like the government is using taxpayers' money to favour a specific company to save it, which can again raise questions on the government's leadership. Still, the likelihood of government intervention is high as the amount of damage that can happen due to the company going bankrupt is huge.

What are the possible scenarios that may play out?

• The government decides to bail Evergrande out by pumping more capital and saving it. This will save the banking system from taking a hit and the people who have already bought homes and help stabilize their economy.
• Another option is that the company is restructured to allow ongoing projects to get the required resources to complete them. This will allow people owning homes to get their houses though depending on the restructuring, can cause banks to take a hit by having to let go of the loan repayments.
• In case the government decides not to step in, it can cause a major hit to Chinese banking and housing industry, which will affect other industries as well.

What does this mean for India?

As tensions with China have only increased in the recent past, India has decreased its dependence on China on many fronts and the move towards an Atmanirbhar Bharat can turn out to be in our favour. With uncertainties in the Chinese economy, FII (Foreign Institutional Investors) will likely take their money out of China and look for other growing markets to park their money. With India's stock market on a bull run, India is well-positioned to get those investments that can further drive the stock markets to new heights. Hence even if some corrections happen, India should be able to save itself from taking major hits.