Evergrande Crisis — an IL&FS Moment for China?

The Evergrande debt crisis has laid bare, the liquidity issues being faced by real estate companies in China. Global financial markets are closely tracking the implosion of Evergrande, China’s second biggest real estate company. Evergrande presently owes over $300 billion to its creditors and is required to pay $ 8.5 billion in interest payouts. The Chinese government has indicated that

Evergrande will not be in a position to make the interest payments and the central bank of China has not provided any indication that it will bail out Evergrande.

Considering China’s position as the second largest economy, there are concerns that this could be China’s ‘Lehmann’ moment (particularly since the recession in 2008 was triggered by the sub prime mortgage crisis in the US). Given China’s position as a major commodities imported, the Evergrande crisis can also have repercussions on the commodities market.

Warning Bells

There had been various red flags as a follow up to the present crisis. The Chinese real estate market has long faced accusations of window dressing of books, vacant townships and untenable debt. Chinese regulators had been cracking down on various conglomerates, including Alibaba, Didi Chuxing and Weibo. Similar to the US real estate market in 2008, inflated real estate prices led to

higher property prices for homebuyers. This resulted in a large chunk of savings of the homeowners being diverted to purchasing of property rather than consumables. The Chinese government’s focus on increasing domestic consumption rather than relying on foreign investment and exports to

bolster their economy has been frustrated on account of the pressure being faced by their real estate sector. Accordingly, the Chinese regulators had been cracking down, particularly on corrupt enterprises as well as putting a cap on the borrowing ability of major Chinese conglomerates, and this had particularly ended up impacting their real estate developers (including Evergrande). This

also led to a stagnation in the share value of Evergrande given the cap on borrowings and this loss of confidence also led to homebuyers who had placed deposits for under construction flats demanding their money back. The other vertical of Evergrande, its wealth management business also took a hit

since investors in their wealth management business demanded recouping of their investments.

Impact on India 

Economic relations between China and India have been strained of late, particularly due to the border clashes last year. The Indian government has enacted a number of protectionist measures since last year (including imposing restrictions on investments by entities owned or controlled by entities based out of countries sharing a land border with India, including China). Similarly, the

government also imposed various restrictions on participation by Chinese entities in public procurement contracts. To an extent, the Indian economy is therefore insulated from ripples in the Chinese economy.

However, China’s position as one of the largest commodities importers will inevitably lead to pressures in the Indian commodities market. It is expected that steel and iron ore companies may see an impact in the coming days, since the Chinese real estate market was a major importer of these commodities from India. Further, in case of a Chinese economic slowdown and depreciating

value of Yuan, Indian commodity export companies are expected to face increased competition in exports.

Since the Indian regulators have already imposed restrictions on Chinese investments, the risk of any reduction in investments from China has been greatly abated and this is expected to greatly insulate the Indian economy from the probable slowdown to hit the Chinese economy. In addition , given the

pressure on global bond markets due to the Evergrande crisis, investors will be looking to recoup their investments from other jurisdictions. This, coupled with the recent Chinese crackdown on Chinese conglomerates presents a shining opportunity for Indian government to convince global manufacturers to shift base to India.

Lessons can also be taken from the Indian experience of IL&FS. The government took rapid steps of substitution the board of IL&FS and appointing a highly competent board, which has helped steer IL&FS out of rough waters. While there are expectations of a bail out of Evergrande, the recent attitude of the Chinese government has all but ruled out any such expectations. One can only hope

that pressure from institutional investors ultimately convinces the Chinese regulators to take some form of corrective action (including a partial, if not complete bailout).

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