China's Evergrande Crisis

Recently a letter leaked, which?Evergrande, the most prominent real estate developer in China, a global Fortune 500 Company, sent to its employees stating that the company is on the brink of collapse.

The company's?debts?have reached a staggering $300 billion. To give an idea of how enormous this amount is, the total market capitalization of Reliance Industries, the biggest company in the Indian economy, is around $230 billion.

Let's figure out how and why this happened.

This started in the year 2000 itself when the Real Estate sector was booming, and the prices were going up at a steady pace. People began their journey and tried their fortune in the real estate sector. China too provided relaxation, and debts became inaccessible in the growth-hungry economy. Due to relaxations, the companies started taking heavy loans to boost their business, resulting in high deficits.

At that time, the Chinese government didn't keep a tap of debts open for them. But they are now forcing the companies to start paying off debts. In August 2020, the Chinese government came up with rules (also called the 'three red lines') stating how much a property developer can borrow given its financial position as measured by three debt metrics. The new rules practically cut off Evergrande from taking on any more debt on its balance sheet. This was a big hit to Evergrande's business as it engaged in heavy borrowing to run its business.

To counter this, the company started selling Wealth Management Products. They gave expensive gifts to its employees, making them believe the company was doing well financially. They also started selling their fixed deposit scheme promising their investors a minimum of 10-12% return annually. People, believing a Fortune 500 Company, started depositing money in the company's scheme without knowing the ground reality.

Since the land was limited and the real estate sector competition was high, prices increased drastically. Eventually, the prices grew so high that the country had no buyers for land. The company was thus forced to sell its land and other properties at steep discounts to meet its debt obligations. This resulted in Evergrande's insolvency.

As of now, the company has more than five hundred incomplete projects, and are struggling to find their way out from this crisis.

Let us now discuss the?why??of this crisis.

When Evergrande was doing good financially in early 2000, it didn't manage its expenses and revenue well. Instead of repaying loans and debts, the company used the money to diversify into various businesses. It bought a soccer team and a stadium at an investment of?$1.7 billion. It got into the electric vehicles business, food Beverage industry, developed theme parks, none of which were successful.

Shockingly, the promoters of Evergrande were reported to have taken $4 billion dividend income from the company in the last three years. Also, the company distributed dividends more than its annual revenue in the financial year of 2019-20.

The total worth of the real estate sector of China is 30% of its economy. Therefore, if things do not work well, this crisis can surely be evil to China in the coming times.