Explainer: What is Evergrande and why does it matter to Australia?

What is Evergrande and why does it matter to Australia?

Who are they?

China's second-biggest property developer, by sales, the group develops apartments for middle and high-income earners in China's major cities, including Chongqing and Tianjin, although that's not the only industry it's involved with. The company also has a mineral water brand as well as owning resorts and amusement parks, among other investments.

What's the big deal?

They're heavily indebted, to the tune of more than $170 billion. The company borrowed heavily, with a reliance on short-term credit to service its debts, and has fallen victim to the Chinese government's tightening policy toward this type of borrowing. Bloomberg reported earlier this week that the company had recently missed payments to two of its biggest bank lenders.

There was speculation this week that it would be unable to meet a scheduled interest repayment to one of their bondholders, meaning the company would be in default after a 30-day grace period, although today it was announced that the company would meet a payment due on September 23, leading to widespread relief in international markets.

It's not just banks that are owed money by Evergrande - suppliers and even former employees are owed money, the latter the result of practices like departmental funding rounds to make up for previous funding shortfalls. On top of that, there are the future homeowners who have given the developer a deposit and are awaiting completion of their new homes.

Why all the Lehman Brothers comparisons?

Some of the commentary this week has revolved around the scale of Evergrande's debt, its size and the extent to which it is embedded in China's economy, speculating that any collapse could trigger a 'financial contagion' effect throughout China's property and financial markets that would spread to international markets.

Some commentators have made comparisons to the last financial contagion event: the collapse of Lehman Brothers during the Global Financial Crisis (GFC).

Lehman Brothers, for those of you for whom the GFC is a distant memory, were the fourth-largest investment bank in the United States prior to filing to bankruptcy in 2008. Their heavy exposure to subprime mortgages, and their lack of capital to meet the sudden deterioration in that market, led to their collapse, which in turn had economic reverberations around the world.

It's important to remember that despite the comparison, there is a key distinction between the two companies: Lehman Brothers was an investment bank with global debts, whereas Evergrande is a property developer whose lenders are mostly located within China.

"This is a big event for Chinese financial markets and probably for the [Chinese] property market as well, but I don't think its a Lehman moment," said economist Saul Eslake, of Corinna Economic Advisory.

"At one level Evergrande's liabilities of around $300 billion are half of what Lehmans were at a time when the Chinese economy is much bigger than the U.S.'s was in 2008," he said.

Mr Eslake referenced the collapse of the American Insurance Group, which occurred the day after Lehman's bankruptcy, as evidence of the systemic issues faced in 2008.

"What was so damaging from the collapse of those two [Lehman Brothers and AIG] is that they were both so intertwined with the global financial system that it set off cascade effects," he said.

Evergrande's liabilities, by contrast, were largely domestic.

"Whereas Evergrande liabilities are to Chinese banks and to a whole lot of individual Chinese buyers who've decided to buy properties from them," Mr Eslake said.

How does all of this relate to Australia's economy?

Comparisons to Lehman Brothers may be overstated, but that doesn't mean a collapse of Evergrande, and any resulting meltdown of China's property market, wouldn't have any impact on Australia.

Typically, when China's economy does well, so does Australia's. Chinese manufacturing leads to demand for Australian commodities like iron ore, and any downturn in economic activity there will inevitably lead to a fall in prices here, including in the value of the Australian dollar.

But Mr Eslake said that the extent of any drop in iron ore prices had been rendered moot by China's recent policy decisions to crackdown on steel production pollution.

"I don't think it does at all [have flow on effects for Australia] except perhaps to the extent that it weakens one of the most significant sources of demand for steel and hence iron ore, but that seems to be happening anyway. The price of iron ore has halved since China ordered its steel mills to cut production for environmental reasons," he said.

There has been speculation that the spectre of an economic collapse in China's property market has the potential to make share market investors nervous, a phenomenon already witnessed by price fluctuations in the share and currency markets leading up to this week's announcement from Evergrande.

Would a property market collapse in China affect house prices here?

In terms any collapse in Chinese property directly leading to a collapse in Australian property prices, homeowners and investors had little to be worried about, Mr Eslake said.

"Certainly I would say there's no reason why Australian property prices would go south just because the Chinese market did, that didn't happen here when American prices went south [in 2008]," Mr Eslake said.

What's next for the company?

Evergrande may have made its latest interest payment, but there are several more due this year, some of which are larger than that paid this week, and it's unclear at this stage how Evergrande plans to meet them.

The Chinese government could step in and restructure the company's debt, though there has been speculation that they may be less likely to do so than in the past, with the government keen not to encourage the kind of borrowing behaviour which has led Evergrande into this mess.

Mr Eslake explained that Evergrande's current predicament was likely a result of the Chinese government's policy efforts, similar to the changes witnessed in the private education and tech sector there.

"The Chinese authorities have gradually been seeking to deleverage the financial system and to steer lending away from property development towards other things they think are more worthy," he said.

"Xi Jinping has said recently that homes should be for living in [not used as a vehicle for wealth]," he said.

He said that the Chinese government would likely do what it takes to prevent the situation spilling into the broader economy and affecting domestic home buyers, and that they "had the money to do so".

This story What is Evergrande and why does it matter to Australia? first appeared on Newcastle Herald.