Skip to main content

China's Lehmann's Moment- Are We Heading Towards Another Recession?

Most of you would remember the tough economic times the whole World saw in 2008. If yes, you would also be aware of the reasons behind such times. Yes, the subprime mortgage crisis in the United States and one of the consequences of it was the fall of Lehmann's Brothers Investment Bank.

The fall of the 4th Largest Investment bank in the US caused a huge liquidity crisis in its economy which had huge contagion effects on the whole world. Most of the economies in the world were pulled into recession or a slowdown leading to huge layoffs across the sectors.

Today after 13 years, the world is again at the brisk of another Lehmann's Brothers like crisis and this time it is in China. The second-largest real estate developer of China, Evergrande is on the verge of defaulting on its due payments. The question here arises is how it is like Lehmann Brothers and how it is going to impact the World, lets find out.

Evergrande and the crisis

Evergrande is not only China's second-largest real estate company but also the world's highest debt-ridden company in this sector. Evergrande started its operations in 1996, It followed a business model of borrow and build. It did help the organisation become a behemoth of China's real estate economy but the cost of it was a huge debt. As of today, Evergrande has a total debt of $330 billion or 2 trillion Yuans which is almost 2% of China's entire GDP.

Evergrande in the past few months have warned about its inability to pay the debt. This has made the markets and investors across the world very nervous. The first thing that comes to mind is why now it failed and never before? What changed in recent times?

One obvious answer is Covid 19 and the lockdown imposed to curtail the spread of the virus. Covid 19 without any doubt affected the real estate sector causing a decline in the revenues for real estate players. But the second more important reason is China's policies to turn its economy into a self-sustained consumption-driven economy. One of the actions taken by the Chinese govt. to achieve this is a crackdown on debt-ridden companies. The "three red lines" plan introduced by China made it difficult for companies which are already having high debt ratios to borrow more funds. I will cover "three red lines" in a separate article.

Latest Updates and what Analysts predict

In the week gone by, Evergrande was supposed to make a coupon payment of $83 million for its dollar-denominated bonds on 23rd September. As per the reports, the payment was not made and now the company has 30 days grace period to make the payment before the lenders declare the firm as defaulted. On 29th Sept, there is another $45 million due and it would be interesting to see if Evergrande does that payment or not.

Analysts across the world have their eyes set on the turn of events in this crisis. Yet, many believe that even if the company defaults, the repercussions would be limited to China. There would be no or limited contagion effect on other economies. The rationale they give is that most of the lenders to Evergrande are Chinese banks only. As of the current date, China has a comfortable cushion in its reserves to absorb a $330 billion default.

But some analysts think that this could be another crisis of Lehmann brothers' scale. It may have the potential to pull economies across the World into recession given the huge investments of countries like the US and European Nations in China.

China's Options

In case of Evergrande default, markets fear that it might create 2008 like situation. Investors might choose to stay away from the markets making other real estate companies suffer. The crisis in real estate sectors would be inevitable and would eventually lead to a liquidity crunch across world economies.

Analysts say that now it is imperative for the Chinese Govt. to step in and take some action. Chinese Govt. has three options

Scroll to Continue

1. Chinese govt. bail out the debt-ridden Evergrande and propose a debt restructuring. In such a scenario, investors would lose some of their money but a large crisis could be mitigated. This was recently done by the Indian govt. in the case of IL&FS.

2. Second option for the Govt. is to nationalise the firm and take care of its day to day activities. In such a case, govt. can also work out a way with the investors on the repayment of dues and regain the confidence of Investors.

3. The last option for the Chinese Govt. is to let the company default. Trust me the way things are turning out it seems the Chinese Govt. is more inclined towards this option. But, in such a scenario, it would become imperative for the Govt. to artificially pump the money into the system to keep the economy going. This was done by American Govt. in 2008 where they chose not to bail out the Lehmann Brothers. The government at that time pumped trillions of dollars into the economy in form of Quantitative easing.

Path Ahead for India

It would be interesting to see what option does the Chinese govt. choose to avoid the crisis. But one thing is for sure, China will suffer a dent in its image and this is where India must see a silver lining.

India definitely could see some temporary shocks from the crisis in China. But in long term, India could be a lucrative destination for foreign investors. This is also backed by the robust performance of Indian companies primarily in the IT sector in the recent past. Investors looking for growth will look upon Indian companies to deliver. India will have to make sure to live up to the expectations by countering its Internal problems and focus on business and growth.

Edit 1

There have been few recent developments (both positive and negative from investor's perspective)on Evergrande's crisis.

1. Evergrande debt list pilling up as few exposures have been listed out by the lenders where Evergrande is guarantor. This makes it Evergrande's liability to pay in case the original obligor defaults.

2. Evergrande has issued a statement that it would sell its $1.5billion stake in Shengjing bank to pay some of its obligations.

3. PBOC, the central bank of China has given an assurance to the house owners that their interests would be the top priority for China. It has also pumped some liquidity into the market to calm the nervous investors.

Edit 2(02/11/2021)

1. Evergrande narrowly escaped the default as it made the pending coupon payment. Also, Hengda(Evergrande subsidiary in Mainland China) has announced payment of coupons to its domestic investors. This has caused nervousness in the foreign investors as the parent company (Evergrande) had already defaulted thrice on its foreign obligations.

2. However few other real estate companies of China namely Fantasia Holdings, Sinic Holdings and China Holdings have defaulted on their recent coupon payments.

Related Articles