Evergrande crisis: How can it impact UK markets in the long term?

Highlights 

  • Reports of interest payment default by the Evergrande Group led to the fall of the global stock market.
  • FTSE100 index slipped to its three-month low, below the 7,000 level, following the news.
  • Evergrande Group owns over USD 300 billion to more than 270 financial institutions, impacting the Chinese economy like the Lehman Brothers crises.

Global stock markets suffered a sudden and sharp decline at the start of the week on fear of default by China’s second-largest real estate company, Evergrande Group, which owns over USD 300 billion, almost 6% of the total debt of China’s property sector.  Guangzhou-based Evergrande Real Estate has a property business in 280 cities and directly employs close to 200,000 people, and creates more than 4 million jobs indirectly. Besides the real estate business, the company also operates other businesses like wealth management, electric cars and owns China’s largest football team- Guangzhou FC.

Why Evergrande went bust

Over the years, Evergrande Group’s rise as the second largest company was financed through debt. The company borrowed from banks and issued bonds with higher interest rates which attracted domestic and international investors.

Before the Covid-19 pandemic, the company managed its debt as the Chinese housing market was booming and demand was high. However, this year the housing market witnessed a sales slowdown, and China also took steps to control the large borrowings in the real estate sector. The combination of factors caused trouble for the company, making it struggle to service its debt; as a result, the company’s share price is down over 80% this year.

Loan default and fall in Chinese economic growth

As per market experts, the Evergrande crisis is somewhat similar to the Lehman Brothers crisis of 2008, which led to the worst financial crisis. Therefore, the Evergrande Group problem might damage the Chinese economic growth and impact global markets as well.

  • Default by the group will impact China’s financial system. Evergrande Group owes money to over 270 financial institutions. If Evergrande defaults, banks will be less likely to lend money to businesses, leading to a credit crunch in the Chinese economy. Also, foreign investors might move away as the Chinese market will be less attractive for investment.

 

  • Many small constructions firms, material suppliers and design companies do business with Evergrande. These firms might face the risk and business loss and may file for bankruptcy.

 

  • Since the company has a large-scale operation in China, many people must have bought properties and paid an initial deposit which will be lost. Also, large scale job losses will happen if the company shutdown.

 

Turmoil in global stock market

The global stock market witnessed a drastic fall on Monday following reports that the company might default on the interest payment, which was to be paid on Thursday. However, the company said it had struck a deal with borrowers on interest payment which led to temporary stability in the markets.

Evergrande impact on FTSE 100

                                                              (Data source: Refinitiv)

FTSE100 index was at a three-month low below the 7,000 following the news but managed to bounce back as fear of default eased.

Impact on mining sectors

The mining sector was majorly impacted after the default news came out. Investors fear default by a major company could lead to correction in the property prices and adversely impacting the construction activities in the second-largest economy, creating a demand shock for the metals. As a result, Blue-chip index FTSE100, which comprise major mining sectors companies, were down, with many mining stocks slipping to near multi-week lows.

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