Evergrande’s Risk To The Australian Economy

Feature Stories | Oct 27 2021

The risk of China’s largest property developer going into liquidation remains real, but even if Evergrande doesn’t, there are clear risks ahead for the Australian economy.

-Evergrande’s debt systemically significant
-Beijing orchestrating a property market slowdown
-Financial risk considered contained
-Risk to commodity demand is substantial

By Greg Peel

The collapse of Evergrande would not, analysts agree, spark a “Lehman moment”, referring to the collapse of one of America’s largest investment banks in 2008, which shifted the global “credit crunch” to that point into a Global Financial Crisis.

On the day it appeared Evergrande might well collapse, the Dow fell over -600 points and global markets followed suit. But analyst confidence that another GFC was not upon us swiftly relieved markets, at least until the Fed started to send more hawkish signals, exacerbating the September sell-down already in train.

Subsequently, Evergrande faded from the minds of investors, with news out of China not always overly forthcoming. However, the issue of Evergrande’s future, if it has one, has by no means yet been resolved. To that end, while analysts may not foresee another GFC, they still believe the risk is substantial for the world’s second largest economy, and that those risks flow on to the global economy.

And in particular, the Australian economy.

How did we get here?

Evergrande is a very significant Chinese property developer, notes Auscap Asset Management, with some 1.5 million dwellings under development, spread across 778 projects in 223 cities, in a country that produces approximately 15 million new dwellings a year. Property development is an enormous driver of economic growth within China.

Evergrande employs 200,000 people directly and reportedly creates 3.8 million jobs per annum indirectly in its construction and other businesses. The problem is that it has approximately US$300bn of liabilities, US$170bn of which is due within twelve months, and has only one tenth of that amount in cash on hand.

To put that into context, US$300bn was approximately the net debt of the Australian federal government prior to the pandemic, and is equivalent to 2% of China’s GDP. These obligations are so large that many consider the business to be systemically important, and it is at risk of defaulting on its obligations. Evergrande has missed bond payments, is late in paying employees and has not paid due invoices from suppliers and other creditors.

One of those bond payments, an amount of US$83m, was due to be paid on October 23 and at the last minute, Evergrande made good. But the company is by no means out of the woods.

Ironically, one might suggest, Evergrande’s problems have their roots in the GFC.

China’s response to the GFC was one of massive fiscal stimulus, supporting the country’s rapid urbanisation, and driving strong economic growth. This resulted in a property boom as demand for housing in the cities ran wild. Like with all booms, a stumble followed, in this case in 2014-15, leading to a sharp pullback. Beijing’s response was to ease property policies, and to support the market by investing in “shanty town” renovation.

The growth in China’s property market was a major element of strong economic growth, and substantial growth in debt. But economies cannot grow at such a rapid pace forever. Eventually they mature.

Housing demand in China, notes JPMorgan, is sourced from new family formation (marriages), urbanisation, public housing (renovated shanty towns) and investor demand. By 2017, China was experiencing lower birth rates, a decline in new marriages, the end of shanty town investment subsides from the government, a slowing in the pace of urbanisation, and a crackdown on speculative property development. This is when housing demand peaked.

JPMorgan estimates that demand fell from 20.2 million units in 2017 to 16.4 million in 2020, and will fall to 12.7 million by 2030. Note that immigration is another driver of housing demand, and that came to a halt in the pandemic, which in China is not over yet.


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