“A wave of fear over Chinese economic growth swept through global markets on Monday,” say Narayanan Somasundaram and Jack Stone Truitt on Nikkei Asia. Markets dropped in Asia, Europe and the US, where the Dow Jones Industrial Average at one point fell 972 points (almost 3%) before paring losses to 1.8% before the close. Behind the bout of jitters lay the fate of Evergrande, China’s most indebted property developer, which is teetering on the brink of default.
An Evergrande bankruptcy would “amount to a financial tsunami”, says Caixin. The firm has ¥2trn (£227bn) in known liabilities (about 2% of China’s GDP), plus unknown amounts of off-book ones. Some analysts say it could be “China’s Lehman Brothers”, referring to the 2008 collapse of the US investment bank that helped trigger the global financial crisis.
Risks are manageable
That’s an exaggeration, say analysts at Barclays. Evergrande is big and there will be consequences for China’s real-estate sector. “But a true ‘Lehman moment’ is a crisis of a very different magnitude.” It would entail a “lenders strike” across the financial system, a “sharp increase in credit distress” outside real estate and banks not being willing to lend to each other in the interbank market.
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Evergrande won’t cause that. First, its financial-system liabilities are much smaller than its headline liabilities (more than half the total is what it owes to suppliers) – it has around ¥227bn in bank loans and about ¥158bn in offshore and onshore bonds. Second, China has “navigated successfully through a number of defaults and restructurings” lately, including the financial conglomerate Huarong, which had about ¥1.4trn in liabilities. There’s no reason to expect policymakers to mess up this time. Third, Evergrande – and other Chinese property firms – aren’t at the mercy of wholesale funding markets, as Lehman was. “In an extreme scenario where capital markets are shut to all Chinese property firms … which is not occurring … regulators could direct banks to lend to such firms, keeping then afloat.”
The crisis is not a Lehman moment, concurs Bill Bishop in his Sinocism newsletter. “But it is ugly and will get uglier.” It’s rash to assume policymakers “have a full understanding of all the Evergrande liabilities and interconnections with other firms” Some form of bailout will happen, but “the lack of guidance from regulators seems to be spooking investors”.
This “is far from being a well-managed process”, agrees The Economist – hence bonds from other developers such as R&F, Fantasia and Sinic have slumped over fears they may be next. The underlying issue is that Xi Jinping, China’s president, is cracking down on excess debt in real estate as “one of several campaigns [he] is using to remould the country”. So the contagion risks aren’t just about markets. Real estate accounts for 20%-25% of GDP, thus “an extended campaign against developer debt could significantly lower China’s growth prospects... and lead to greater economic and financial turmoil down the road”.
Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.
Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.
He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.
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