September 15, 2021

Blog Author : Tom J. Canova, Co-Founder, CMO Modevity

There has been much news coverage over the last eighteen months regarding the Covid Pandemic and the Supply Chain Risks to US Economy.  The overall concerns of the American Supply Chain have been highlighted by the Biden Administration reviews of the US Supply Chain Risks and focus on “critical” products and sectors could impact manufacturers, distributors, and others.  The Presidents Executive Order – EO that will require the government to produce unclassified assessments of key industries and their supply chains, including semiconductor manufacturing, electric car batteries, medical supplies, and rare earth elements such as the ones used in iPhones and military systems, etc.

Now American economists and corporate executives are increasingly concerned about other economic developments of the China economic engine and overall supply chain.  One of their concerns is focused on the Chinese real estate development boom that is increasingly looking to face unsustainable headwinds!

Every once in a while, a company grows so big and complicated that governments fear what would happen to the broader economy if it were to fail.  In China, Evergrande, a sprawling real estate developer, is that company.

Evergrande has the distinction of being the world’s most debt-saddled property developer and has been on life support for months.  A steady drumbeat of bad news in recent weeks has accelerated what many experts warn is inevitable: failure.

The ratings agency Fitch said this week that default “appears probable.”  Moody’s, another ratings agency, said Evergrande is out of cash and time.  Evergrande is faced with more than $300 billion in debt, hundreds of unfinished residential buildings, and angry suppliers who have shut down construction sites.  The company has even started to pay overdue bills by handing over unfinished properties.

Observers are watching to see if Chinese regulators make good on their pledge to clean up the country’s corporate sector by letting “debt bombs” like Evergrande collapse.

In its glory days a decade ago, Evergrande sold bottled water, owned China’s best professional soccer team and even briefly dabbled in pig farming. It became so big and sprawling that it even has a unit that makes electric cars, though it has delayed mass production.

Today, Evergrande is seen as a unstable threat to China’s biggest banks. The company, which was founded in 1996, rode China’s epic property boom that urbanized large swathes of the country and resulted in nearly three quarters of household wealth being tied up in housing. This put Evergrande at the center of power in an economy that came to lean on the property market for supercharged economic growth.

Its billionaire founder, Xu Jiayin, is a member of the Chinese People’s Political Consultative Conference, an elite group of politically well-connected advisers.  Mr. Xu’s connections probably gave creditors more confidence to keep lending money to Evergrande as it grew and expanded into new businesses. Eventually, though, Evergrande ended up with more debt than it could pay off.

Evergrande might have been able to keep going if it weren’t for two problems. First, Chinese regulators are cracking down on the reckless borrowing habits of property developers. This has forced Evergrande to start selling off some of its sprawling business empire. That’s not going so well. It has yet to sell its electric vehicle business, despite talks with prospective buyers. Some experts say buyers are waiting for a fire sale.

Second, China’s property market is slowing and there is less demand for new apartments. This week the National Institution for Finance and Development, a prominent Beijing think tank, declared the property market boom “has shown signs of a turning point,” citing weak demand and slowing sales data.

Much of the cash that Evergrande has been able to drum up has come from presold apartments that aren’t yet completed. Evergrande has nearly 800 projects across China that are unfinished, and as many as 1.2 million people who are still waiting to move into their new homes, according to research from REDD Intelligence.

In August it made a quarter fewer sale than it did a year ago.  A campaign by the central bank to tame property debt and reduce the banking sector’s exposure to troubled developers should mean that an Evergrande failure would have less of an impact on China’s financial system.

Panic from investors and home buyers could spill over into the property market and hit prices, affecting household wealth and confidence. It could also shake global and American financial markets and make it harder for other Chinese companies to continue to finance their businesses with foreign investment.  Writing in The Financial Times last week, the billionaire investor George Soros warned that an Evergrande default could cause China’s economy to crash.  And if that was to happen, we can all surmise the calamitous impact on the American Business Supply Chain and overall Economy going forward.

Blog Post by: Tom J. Canova, Co-Founder, CMO Modevity

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September 15, 2021