What Are The Root Causes Of The Evergrande Crisis And How Will They Affect The Chinese Economy?

China Evergrande Group has racked up debts totaling more than $300 billion and its dollar-denominated bonds have been trading at distressed levels because investors expect the company to eventually default.

Recently, the property giant has been able to avoid defaulting on those debts by making overdue interest payments shortly before the expiration of their 30-day grace periods. Many investors are concerned whether or not Evergande’s default could spill over into the rest of the real estate market.

The real estate industry in China has grown rapidly over the last few decades and Evergrande has been at the forefront of that development. It became the biggest real estate enterprise in the country through an accelerated growth strategy that relied mainly on funding from down payments from property buyers and hefty bank loans. But now, the company’s managers are in a race against time as creditors appear to be bracing for an eventual debt restructuring that would have to rank among the largest ever in China. Evergrande did not respond to an emailed request for comment.

 As a seasoned entrepreneur doing business in China for 30 years, I foresee that there will be additional regulations and reforms in terms of how business is run in the real estate industry.

In China, housing, education and medical services are what people really care about. As capital has continued to flow into these three markets over the year, and in the case of property development, the price of housing has risen higher and higher in China.

In order to control the liabilities of real estate enterprises, China’s regulatory authorities recently established the “three red lines” to limit property developers’ ability to increase borrowing, namely, excluding pre-payments the debt asset ratio cannot exceed 70%, the gearing ratio cannot exceed 100% and the short-term liquidity cannot be smaller than 100%.

In my view, the reform of the real estate market, including the requirement for all real estate developers to adhere to the “three red lines,” is beneficial for the medium and long-term economic growth of China. Specifically, housing prices in Chinese cities will finally come under control, lessening the financial burden of Chinese people which will in turn lead to an increase in disposal income levels. We are witnessing the initial waves of “retaliatory consumption” right now.

The real estate development industry, in my view, has disproportionally utilized social resources including capital and land that otherwise could be available for other economic activities. In the near future, I anticipate that small and medium-sized companies will be able to obtain more and cheaper capital from banks and financial institutions. Their successes (most new ideas and innovations come from small and medium-sized companies) will be instrumental to the next growth stage of development for China’s economy.

Businesses need to anticipate the direction of the implementation of the these policies, understand the rationale behind China the concept of “common prosperity.”