China’s Evergrande Real Estate Group is probably one of the largest companies you’ve never heard of. Headquartered in Shenzhen, China, the company is one of the world’s largest property developers. With prior year revenues of $73.5 billion, it sits at No. 122 in Fortune’s Global 500 of the world’s largest companies. It employs a massive workforce — 123,276 as of Aug. 2 — and boasts it indirectly creates more than 3.8 million jobs every year.
As a privately-held company, Evergrande represents part of China’s grand foray into capitalism. By most accounts, China first dipped its collective toe into modern-day capitalism in the late 1980s to early 1990s. But make no mistake, China’s capitalistic venture has been, and remains, a highly-controlled endeavor. China’s economy, and everything that relates to it, is overseen by the Communist Party.
Over the past 40 years, China’s capitalistic experiment has created the world’s second-largest economy, behind only the U.S. But much of China’s “tiger economy” was built not on organic growth, but on the mass accumulation of debt. Under the mandate of the Communist Party, factories are built, infrastructure jobs are green-lighted and goods are produced regardless of need or demand. This production costs money, and the Chinese government has accumulated a mountain of debt to meet its production endeavors.
Enter Evergrande Real Estate Group. With a similar “growth at any cost” mentality, Evergrande has accumulated a mind-numbing $300 billion in debt. Much of Evergrande’s growth was funded not by revenues, but by borrowing vast sums of money. Ultimately, Evergrande’s crushing load of debt — for which it needs sufficient cash to satisfy principal and interest payments — has left it on the brink of financial collapse.
Over the past few years, Evergrande’s sales have significantly declined. The global pandemic has hindered property development. China’s government has also placed tighter borrowing restrictions on real estate developers. Combined, this has created a massive cash crunch for Evergrande. To raise funds, Evergrande has tried selling off some of its assets but with little success.
Evergrande’s financial woes have weighed heavily on global stock markets. On Monday, Wall Street was hoping to recover from a three-consecutive-week decline in the Dow Jones Industrial Average (DJIA). But Monday’s optimism was short-lived. China’s government announced it would not step in to guarantee Evergrande’s outstanding debt. The news sent global stocks reeling, including a 614-point sell-off in the DJIA.
In the event of Evergrande’s collapse, the brunt of the fallout would lie in China. Banks, lenders, investors, home buyers and suppliers, among many, would be left scrambling to recoup just a fraction of the money owed to them. This would raise concerns over “cross default.” By not receiving their money owed from Evergrande, companies might be forced to default on their own loans and obligations. There’s also the risk of contagion, that the fallout spreads to other regions and nations around the world.
So, given the potential fallout, why would China allow one of its largest companies to essentially crash-and-burn? First, China is starting to pivot away from fueling economic growth through the accumulation of debt. The size of China’s debt is reaching critical mass and even the most loyal of Chinese policy makers realize the current pace of debt accumulation isn’t sustainable. Thus, what’s now considered good for the nation is also deemed good for privately-held companies, including Evergrande.
Chinese President Xi Jingping is also in a policy shift aimed to reign in capitalism and lean more toward China’s Communist Party roots. Over the past several months, Xi has issued crackdowns on several capitalistic institutions such as technology, e-commerce, internet providers and even food delivery services. Xi’s goal is to ensure these companies fall in line with Communist Party goals and initiatives.
In the upcoming days, the world will eventually learn of Evergrande’s fate. Will Xi swoop in at the last minute to save the company or will it be allowed to simply implode? Ultimately, however, Evergrande may well serve as a sacrificial lamb to China’s policy shifts.
Mark Grywacheski is an expert in financial markets and economic analysis and is an investment adviser with Quad-Cities Investment Group, Davenport.
Disclaimer: Opinions expressed herein are subject to change without notice. Any prices or quotations contained herein are indicative only and do not constitute an offer to buy or sell any securities at any given price. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets or developments mentioned. Quad-Cities Investment Group LLC is a registered investment adviser with the U.S. Securities Exchange Commission.