Jambo Africa Online’s Senior Editorial Correspondent, Francois Fouche, gives us news snippets from across the world that impact on Africa’s economies…
What is the Evergrande debt crisis in China and why it matters to South Africa and the global economy?
- Evergrande is China’s second-largest real estate company.
- As the company struggled to repay creditors, global markets responded with selloffs
- After missing four payments, the company made a key payment to bond holders, staving off default.
- Questions loom about a government bailout and whether Evergrande is in fact too big to fail.
The news that Evergrande, the world’s most indebted real estate company, was on the brink of collapse sent global markets tumbling last month. The company had warned investors that it could default on its debts and ratings agency Fitch had said that default ‘appears probable’ while Moody’s, had said ‘Evergrande is out of cash and time’.
What happened with Evergrande?
Evergrande (previously Hengda Group), founded by Xu Jiayin in 1996 and headquartered in Shenzhen, China, rapidly expanded during China’s housing boom, buying land and delivering over 1300 market-rate and luxury apartment developments in more than 280 cities across China.
As residential sales began to slow in recent years, Evergrande debt increased and the company diversified into other sectors such as electric vehicles, football and even bottled water. Evergrande employs 200,000 people directly and indirectly is responsible for an estimated 3.8 million jobs annually.
So what went wrong?
A regulatory storm brewing
Government regulation in China’s property sector has been increasing as the government has been working to control surging home prices and excessive borrowing.
In 2020, the government imposed the ‘three red lines’ on certain developers to help curb debt levels, forcing them to deleverage. The three red lines policies require:
1. 70% ceiling on liabilities to assets
2. 100% cap on net debt to equity
3. Cash to short-term borrowing ratio of at least one
This resulted in Evergrande unsuccessfully trying to sell off some of its business, evidenced by a leaked letter from Evergrande to the government in September 2020 asking for assistance as they faced a cash crisis, which sparked increased investor concern. An estimated two thirds of Evergrande’s obligations are to homeowners who pre-paid for close to 1.4 million residential properties that remain undeveloped.
The government has also worked to control housing prices, which could further impact developers’ returns and the ability to pay their debt service. Housing is a key source of household wealth in China and if the government succeeds in curbing residential property prices, existing mortgage holders could lose equity in their homes. Household debt now stands at 62% of GDP in China, which has largely been acquired through residential mortgages. This is one reason for such a large amount of Evergrande debt.
The increasing regulatory environment in China could also be a deterrent to continued foreign investment as seen recently when Blackstone abandoned plans to acquire SOHO China due to prolonged regulatory reviews of the deal.
Evergrande debt – a domino effect
As early as 2018 the Chinese Central Bank highlighted in its financial instability report that companies like Evergrande could pose a systemic risk to the nation’s financial system. Evergrande has an enormous web of contractors and other businesses in the region that are owed money from the developer.
In recent weeks contagion fears have intensified as 128 banking institutions and 121 non-banking institutions are exposed to Evergrande. There are also concerns around the impact on commodity prices if China’s demand wanes due to slowing construction.
Real estate situation in China
Evergrande is not the only Chinese developer in trouble. In late October, Moody’s downgraded seven major Chinese real estate companies due to dismal sales and financial projections. A recent prediction from Nomura Holdings, suggests China’s real estate sector is more than $5 trillion in debt.
China’s real estate market accounts for a whopping 30% of the country’s GDP, 41% of the Chinese banking system’s assets are either directly or indirectly associated with the property sector and 78% of the invested wealth of urban Chinese is in residential property. To quell fears of contagion across China’s real estate market, Beijing has pledged to prevent downstream impacts on other real estate companies in the region. There remains, however, great uncertainty as to whether the Government will step in to support Evergrande itself in the event of a default.
Chinese policymakers have continued their efforts to reign in speculatory behavior and over-leverage, recently introducing a proposal to levy taxes on both commercial and residential property. The move, which would be transformative to the economy, would help provide the government with an alternative revenue stream to land sales, which have contributed to the overheating.
The situation in China is a potential canary in the coal mine as housing prices have been surging across major global markets. According to UBS’s Global Real Estate Bubble Index, which ranks cities based on their residential property prices as either “bubble risk”, “overvalued”, “fair-valued” or “undervalued”. Of the 25 cities included, 21 are either a bubble risk or overvalued. Frankfurt, Toronto, and Hong Kong top the list as having the highest bubble risk, followed by Munich, Zurich, Vancouver, Stockholm, Amsterdam and Paris. All US Cities on the list were also ranked as “overvalued”.
Investors are keeping a close eye on Evergrande and Beijing as the future remains uncertain for China’s property market. Globally, as markets contend with rising inflation and potential rate hikes as a result, prices may begin to cool off.
While it is still not clear what will happen to Evergrande, the possible outcomes include bankruptcy, breakup, buy-out, or a bailout by the government. What is clear is that the world needs to closely monitor asset prices and debt levels to preserve the health of an already fragile global economy.
The above is an extract from an article, which first appeared here.
An unprecedented combination of factors is rolling world energy
Soaring natural gas prices are rippling through global energy markets and other economic sectors from factories to utilities.
An unprecedented combination of factors is roiling world energy markets, rekindling the memories of the 1970s energy crisis and complicating an already uncertain outlook for inflation and the global economy.
Spot prices for natural gas have more than quadrupled to record levels in Europe and Asia, and the persistence and global dimension of these price spikes are unprecedented. Typically, such moves are seasonal and localized. Asian prices, for example, saw a similar jump last year but those didn’t spill over with an associated similar rise in Europe.
The IMF’s expectation is that these prices will revert to more normal levels early next year when heating demand ebbs and supplies adjust.
However, if prices stay high as they have been, this could begin to be a drag on global growth.
Meanwhile, ripple effects are being felt in coal and oil markets.
Brent crude oil prices, the global benchmark, recently reached a seven-year high above $85 per barrel, as more buyers sought alternatives for heating and power generation amid already tight supplies.
Coal, the nearest substitute, is in high demand as power plants turn to it more. This has pushed prices to the highest level since 2001, driving a rise in European carbon emission permit costs.
Bust, boom, and inadequate supply
Given this backdrop, it helps to look back to the start of the pandemic, when restrictions halted many activities across the global economy. This caused a collapse of energy consumption, leading energy companies to slash investment. However, consumption of natural gas rebounded fast—driven by industrial production, which accounts for about 20% of final natural gas consumption—boosting demand at a time when supplies were relatively low.
Energy supply, in fact, has reacted slowly to price signals due to labor shortages, maintenance backlogs, longer lead times for new projects, and lackluster interest from investors in fossil fuel energy companies. Natural gas production in the United States, for example, remains below pre-crisis levels. Production in the Netherlands and Norway is also down. And Europe’s biggest supplier, Russia, has recently slowed its shipments to the continent.
Weather has also exacerbated gas market imbalances. The Northern Hemisphere’s severe winter cold and summer heat boosted heating and cooling demand. Meanwhile, renewable power generation has been reduced in the United States and Brazil by droughts, which curbed hydropower output as reservoirs ran low, and in Northern Europe by below-average wind generation this summer and fall.
Coal supplies and inventories
While coal can help offset natural gas shortages, some of those supplies are also disrupted. Logistical and weather-related factors have crippled production from Australia to South Africa, while coal output in China, the world’s largest producer and consumer, has fallen amid emissions goals that disincentivise coal use and production in favor of renewables or gas.
In fact, Chinese coal stockpiles are at record lows, which increases the threat of winter fuel supply shortfalls for power plants. And in Europe, natural gas storage is below average ahead of winter, adding risk of more price increases as utilities compete for scarce resources before the arrival of cold weather.
Energy prices and inflation
Coal and natural gas prices tend to have less of an effect on consumer prices than oil because household electricity and natural gas bills are often regulated, and prices are more rigid. Even so, in the industrial sector, higher natural gas prices are confronting producers that rely on the fuel to make chemicals or fertilizers. These dynamics are particularly concerning as they are affecting already uncertain inflation prospects amid supply chain disruptions, rising food prices, and firming demand.
Should energy prices remain at current levels, the value of global fossil fuel production as a share of gross domestic product this year would rise from 4.1% to 4.7%.
Assuming half of this increase in costs for oil, gas, and coal is due to reduced supply, this would represent a 0.3% reduction in global economic growth this year.
Energy prices to normalize next year
While supply disruptions and price pressures pose unprecedented challenges for a world already grappling with an uneven pandemic recovery, the silver lining for policymakers is that the situation doesn’t compare to the early 1970s energy shock.
Back then, oil prices quadrupled, directly hitting household and business purchasing power and, eventually, causing a global recession.
Nearly a half century later, given the less dominant role that coal and natural gas plays in the world’s economy, energy prices would need to rise much more significantly to cause such a dramatic shock.
Moreover, the IMF expects natural gas prices to normalise by Q2 2022 as the end of winter in Europe and Asia eases seasonal pressures, as futures markets also indicate. Coal and crude oil prices are also likely to decline. However, uncertainty remains high and small demand shocks could trigger fresh price spikes.
Tough policy choices
That means central banks should look through price pressures from transitory energy supply shocks, but also be ready to act sooner—especially those with weaker monetary frameworks—if concrete risks of inflation expectations de-anchoring do materialise.
Governments should act to prevent power outages in the face of utilities curtailing generation if it becomes unprofitable. Blackouts, particularly in China, could dent chemical, steel, and manufacturing activity, adding to global supply-chain disruptions during a peak season for sales of consumer goods. Finally, as higher utility bills are regressive, support to low-income households can help mitigate the impact of the energy shock to the most vulnerable populations.
This article first appeared here.