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It will certainly force the US Fed to remain ambiguous

When the Fed issued its statement on 22-Sep, the statement was deliberately kept as ambiguous as possible. Clearly, the intent was to keep an escape route ready if the Evergrande crisis worsened.

5 mins read   |   25 - Sept - 2021   |  
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written by Bani Thakkar

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What exactly is Evergrande?

It is not a well-known name across the globe like many of its Chinese digital counterparts. But Evergrande is China’s second largest real estate developer with over 1300 projects under its belt. It is also one of the most leveraged realty companies in China with a debt pile of over $305 billion. Now, Evergrande is crunched for cash and on the throes of a default. The concern is that if it really does default, then the world markets could see a sort of Lehman moment.  

What went wrong at Evergrande

Evergrande was leveraged to the hilt, like many Chinese realty companies. But Evergrande had just stretched limits. It was selling units at wafer-thin margins and leveraging the revenues for more borrowings. In fact, that model would have continued for some more time had the Chinese government not clamped down on debt. To control the land price inflation, the Chinese government put credit limits on realty companies based on a matrix of leverage ratios. Clearly, Evergrande was one of the worst hit and was forced to reduce debt. To do that, it had little access to cash. The stock is already down 92% in this year. 

Why it will be a global crisis?

Obviously, when a company with debt of $305 billion fails, it is not going to be an isolated local phenomenon. Nearly 85% of Chinese household wealth is invested in property, so it has systemic implications. But the risk stems on two fronts. Firstly, if Evergrande fails, it will hit realty companies, asset price and bank loans. The resulting hard landing will constrict demand for commodities. Secondly, China could weaken the Yuan as a counter strategy. That is likely to hit many of the emerging markets the hardest. As we have seen in the case of chemical companies, Chinese policy can be quite hard-headed on such issues. 

How it impacts Fed policy

If one were to read through the Fed statement, it almost offered an escape route. The Fed is apprehensive that the Evergrande crisis will not bode well for the US investments and global assets. The last thing that the US would want to do is to precipitate a market crisis by adding a taper risk to the markets. That is why, the Fed has said that conditions were ripe for a taper, although it has stopped short of committing itself to any timelines. To that extent, world markets must thank Evergrande and the debt ceiling imbroglio for the Fed holding on to an ambiguous stance. Even if the Chinese government intervenes, it is not too certain if the crisis and its fallout can be mitigated, or even managed