Evergrande, China’s second-largest property developer, is in trouble. After a decade of massive growth, including investments in a “Fairyland” theme park, an electric car company and a professional football team (Guangzhou FC), it is now struggling to service more than US$300 billion in debt.
So far it has avoided the fate of dozens of unfinished apartment towers – demolished in spectacular fashion in recent weeks – by selling properties to make their payments.
But it is not a sustainable strategy. Credit rating agency Fitch last week downgraded Evergrande to a “C”, indicating an exceptionally high risk of default, “imminent or inevitable, or the issuer is stable”.
Without the intervention of the Chinese government, the company would collapse. Here are three major ways Australia could be affected.
1. Low demand for iron ore
Evergrande’s downfall will reverberate throughout China’s real estate market. Investors and lenders will be more cautious, which may result in a debt crisis. This could severely affect the development of the property, and thus the demand for building materials, including steel, which is mostly made using imported iron ore.
China is by far the world’s largest steel producer, and accounts for about 70% of global iron ore imports. About 60% of that iron ore is imported from Australia.
This trade has made iron ore Australia’s most valuable export commodity, valued at an estimated AU$149 billion in the 2020-2021 fiscal year. About 75% went to China. So any drop in sugar demand will affect the Australian economy.
China is already seeking to cut steel production, a high-energy process, to reduce carbon emissions. The price of iron ore has halved since July.
declining demand for iron ore
A further fall in demand and thus prices will affect the 45,600 jobs directly employed by Australian businesses and industry, as well as thousands of jobs impacting their wages, and government revenue from mining-related royalties and taxes.
2. Overall weakening of China’s economy
Beyond the direct effects, problems in China’s real estate and financial sectors could cause ripples in China’s economy, affecting Chinese demand for other goods and services of which Australia is a major provider.
To put trade with China into context, Australia’s exports to China are almost three times that of our second most valuable market, Japan. Despite iron-ore exports being removed from the equation, China is still our largest export market.
The impact of less China’s purchases from Australia has been the subject of much debate. Some have argued that Australia could compensate by diversifying into other markets. But such things take time. Economists Rod Tires and Yixiao Zhou, who have modeled the effects of the Australia-China trade shutdown, have argued that the short-term effects could be severe.
3. Global Transition
Evergrande’s debt crisis echoes the case of US investment bank Lehman Brothers, whose bankruptcy in 2008 played a big role in staving off the global financial crisis.
Although most of Evergrande’s debt is localized in China, the financial and real estate sectors always run the risk of drowning investors and banks in other markets, leading to a credit crisis across global markets.
Australian stock markets have already fallen from their highs in the past few weeks, certainly due to concerns about China’s economy. The mining sector has experienced real carnage, but there are indicators of general unease in the decline across all sectors.
Will the Chinese government intervene?
Without outside help Evergrande has a very high chance of failure. All the signs are there. It is avoiding bankruptcy by servicing interest payments on its huge debts by selling assets at unfavorable prices.
All eyes are now on the Chinese government as a potential savior through some form of debt restructuring or guarantees.
Read more: Vital signs: Evergrande may survive, but its executives expect a worse fate than debt
So far it has not committed itself, and it has taken a strong stand against high debt by developers. But it may consider Evergrande “too big to fail” – its collapse has potentially catastrophic local and global implications. Hence, the possibility of some kind of intervention to stabilize the situation seems high.
Australians and the rest of the world will have to wait to see which hand the Chinese government will play.