Monday, October 3, 2022
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Evergrande over-indebted saga

In recent weeks, one business news that has been hogging the headlines all over world is that about Evergrande, the second largest real estate company in China. The company manages around 1,300 real estate projects in nearly three hundred cities in the country.

Aside from that, Evergrande is involved in electric car manufacturing, health services, consumer products, video production and even theme parks, and employs more than 200,000 employees.

Unfortunately, Evergrande is now saddled with a debt burden of US$300 billion. In other words, its debt is larger than those of many governments, including Malaysia’s.

Furthermore, Evergrande owes money to more than 170 banks and 121 financial firms. The tendency of banks to lend to large companies with the aim of reducing risks and maximising profits paradoxically has helped to create this dangerous situation.

The current economic uncertainties, partly due to the Covid pandemic, have reduced Evergrande income significantly. It is now in deep financial distress, unable even to service interest on its debts.

Being such a large company, any default on its part will affect China’s property sector negatively. Since almost half of the assets of China’s banking system is either directly or indirectly associated with the property sector as of end-2020, this can adversely affect the country’s financial system.

As such, the Chinese authorities seem very serious to ensure Evergrande remain solvent. But, the company will be forced to scale down its operations, which is bad news for its employees as well as employees of firms that are reliant on it for business. Tens of thousands are likely to lose their jobs.

This sad scenario is actually almost a repeat of the crisis that took place in the United States in 2008. It was known as the Subprime Financial Crisis; and the main cause was also a huge amount of indebtedness associated with the housing sector.

But, the scale of the crisis in the US was much bigger; one of the most indebted firms, Lehman Brothers, eventually went bankrupt. The crisis also spread to other sectors and as a result insurance giant AIG and auto manufacturer General Motors had to be rescued by the US government to minimise the damage to the overall economy.

Nevertheless, thousands of ordinary people still lost their jobs and ended up poor or homeless. A somewhat similar crisis also took place in Japan in 1989 and overindebtedness was again the main factor.

Investors were borrowing money like crazy in order to invest in the stock market as well as real estate. In the beginning, the situation was very exciting because real estate and stock prices were going through the roof, thereby encouraging more parties to borrow money in order to invest.

In reality an asset bubble’ situation was taking place, which eventually burst in November 1989 causing prices to plummet. Many investors became bankrupt and hundreds of thousands lost their jobs, effectively putting an end to the Japanese success story.

The Japanese government has been using borrowed money to spend on stimulus packages. But, after decades of efforts, the economy is still sluggish, while the government debt has grown to be the largest in the world at more than 250 percent of its GDP.

In our country today, as a result of the Covid pandemic, a somewhat similar situation also exists, although not on a scale as large as in the above countries. The best example is the financial problems faced by AirAsia which has a debt burden of RM63.5 billion.

As a result AirAsia has had to restructure all its debts with its creditors and was also forced to reduce its operating costs. Two thousand employees were laid off at the end of last year. The main lesson we need to learn is that debt-fueled economic growth is like taking steroids.

The impressive initial story will sooner or later end in hardship and misery. In the end many governments will be forced to prevent the crises from worsening by implementing stimulus programs using borrowed money too.

Therefore, the large and highly indebted companies may still be able to survive thereby saving their shareholders, as well as the shareholders of their creditors. In other words, the rich will be safe from bankruptcy and misery, unlike the tens of thousands of workers who will be laid off or have their salaries or wages reduced.

The other unfortunate group will be the common people who will have to help the government to overcome its growing debt problem. Subsidies for the poor may have to be cut while tax has to be raised to generate revenue for the government.

At the same time, the costs of housing and food will continue to increase, creating a cost of living problem for the lower income groups. That is the inevitable fate of the ordinary people when an economy is fueled by debt.

This same scenario of suffering among the downtrodden will likely be repeated again and again in the years to come because the powerful and influential financial and political elites are not interested to change the existing arrangement which is beneficial for them.

The status quo will therefore, be preserved even if the suffering is increasing.


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