Want to know how the Evergrande crisis may play out for Indian investors? Listen in on this fictitious water-cooler conversation between Sarojini the equity analyst, Balan the investor and Mukherjee the banker.
Sarojini : What a rally in the Sensex! I think its partly relief that Evergrande didn’t default (technically) on interest payments this week.
Mukherjee : The relief is premature, if you ask me. What’s a $36 million interest payment, when a company owes $300 billion? Evergrande has a series of repayments coming up in the next year and the market’s going to be on tenterhooks every time. Remember that rating agencies such as S&P and Fitch now rate Evergrande’s bonds CC negative, which means highly vulnerable to default.
Balan : But as China’s second largest property developer, it has plenty of assets, no? Evergrande sold property worth RMB 723 million last year and is sitting on a 231 million square metre land bank.
Mukherjee : Like many Indian developers, Evergrande’s main problem is that it has sold most of its homes against advances from customers, who are now wondering if they’ll ever get their apartments. It also seems to have promised high returns to folks on some wealth management products. So Evergrande’s problem really is about whether it has liquidity to meet short-term dues to customers, suppliers and investors. It is not assets, but cash that it is short of. I read that it has liquidity to meet just half its short-term obligations.
Balan : I expect the Chinese government to bail it out. They surely wouldn’t want something of this size to fail!
Sarojini : I’m not so sure. It is the Chinese government that set the match to the Evergrande fuse by creating new rules to cool down China’s over-heated property market last year. In 2020, the Ministry of Housing brought in a new ‘three red lines’ policy which restricted banks from lending to a developer if it crossed three red lines – a liabilities to assets ratio of 70 per cent, 100 per cent net debt to equity and a cash-to-short term liabilities ratio of 1. Evergrande’s fund-raising troubles started because it had crossed these red lines.
Mukherjee : Yes, S&P agrees. It has said that the Chinese government may let events take their course, as Evergrande may not threaten financial stability in China. Evergrande’s loans at RMB 571 billion apparently account for small fraction of China’s bank loans of RMB 160 trillion. Evergrande’s suppliers already knew of the company’s financial troubles. Any Chinese government bailout may help retail homebuyers or investors, but not bond-holders.
Balan : Why are the global markets so jumpy then?
Sarojini : I think they are worried about what this will do to rosy growth projections for the Chinese economy, on which global revival hinges right now. Global agencies were pegging China’s growth at 8.5-9.5 per cent for 2021. After Evergrande, they’re hastily downgrading it to 8 per cent or so. Residential property investments accounts for 10 per cent of China’s GDP and real estate is said to indirectly contribute a fourth of GDP.
Balan : Oh, that’s awful news for the recent party in iron ore, steel and metal stocks based on the commodity ‘super-cycle’ story. China’s property sector accounts for about 20 per cent of global steel and copper offtake and 9 per cent of aluminum demand, I was reading in FT. So this engineered implosion in China’s property sector may mean lower demand projections for these commodities.
Mukherjee : Don’t forget how such events can impact India’s bond markets and the rupee. This will dent the popularity of emerging market (EM) bonds with foreign investors. Chinese developers make up a big chunk of the ‘high-yield’ EM bonds that have been such a hit with foreign investors. If they suddenly develop cold feet, India’s bond markets could see outflows too. Global bond investors already have Fed’s taper plans to contend with. I think Evergrande may affect Indian bonds and the rupee more than the stock market.
Sarojini : Yes, Foreign Portfolio Investor (FPI) participation in Indian bond markets has gone up vertically since the taper tantrum. FPI debt assets in India were about ₹15 lakh crore in 2013, today they’re at ₹42 lakh crore! Unlike our stock markets where domestic retail investors and institutions may be waiting to lap up equities at lower levels, bond investors may be wary of entering at these levels.
Balan : RBI hai na ! Its sitting on record forex reserves and will rescue the rupee.
Mukherjee : It’s not that simple. If RBI sells dollars to rescue the rupee, that sucks out liquidity from the system and leads to a spike in local interest rates. You know how hard RBI has been working to keep borrowing costs low for the government.
Balan : You guys are such pessimists, man. There’s a good side to a commodity cool off too. If crude oil, metal and steel prices fall globally, that would be good for India Inc.’s earnings and for the Budget too. Aren’t you reading all the foreign broker reports saying that this is not a Lehman moment for the markets?
Sarojini : Balan, you are too young to remember this. But just before the Sensex crashed 50-odd per cent in 2008, we had very well-argued research notes about how India was ‘decoupled’ from developed markets and couldn’t be hurt by the global financial crisis because its banks or bond markets didn’t have derivative exposures.
Mukherjee : I would agree. When a market is over-valued, it needs a trigger to correct. The trigger need not be logical or even have a deep fundamental impact. It only needs to topple the first card for the Dominoes effect to kick in. I certainly wouldn’t panic and sell all my equities. But I’d surely be taking some money off the table.
Balan : Just like the FPIs!