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Market braces for impact of Evergrande default

By Mensholong Lepcha

08:29, 17 September 2021

 Burnt fragment of Chinese yuan note
Burnt fragment of Chinese yuan note - Photo: Shutterstock

China Evergrande’s debt pile dwarfs the annual gross domestic product (GDP) of several nations including Sri Lanka, Luxembourg, and Croatia, and it looks increasingly likely to miss interest payment due on 20 September. 

Ratings agency S&P Global called the property developer’s default a “virtual certainty”, while Blomberg reported that Chinese government officials warned domestic financial firms not to expect interest payments due from Evergrande next week. 

Chinese banks are preparing for the default by offloading their US dollar holdings. Analysts spoke to said the lenders are doing this in order to have more cash in-hand in a default scenario. 

PBOC takes action

The People’s Bank of China (PBOC) is also taking action. Today it injected CNY100bn ($14bn) of short-term cash into the financial system through seven-day and 14-day reverse repurchase agreements. 

This was the largest short-term cash injection by the PBOC since February and is a clear reaction to the sheer scale of Evengrande’s debt problems - in March its interest-bearing liabilities stood at CNY674bn ($104.36bn), of which $60bn are onshore China corporate bonds.

The effects of the failure of one of China’s biggest property developers will be significant on Asia’s largest economy. House sales have already begun to show signs of weakness. Rock-bottom consumer confidence saw home sales plunge 20% in August from a year earlier, according to Bloomberg.   

Investors dump Chinese stocks

“The travails of Evergrande are symptomatic of a broader slowdown in the country’s property sector and its economy generally. Even though we doubt this will be enough to knock global markets as a whole off course, given the importance of China’s property sector for demand for industrial metals, we suspect it will continue to weigh on the prices of those metals,” Thomas Matthews, markets economist at Capital Economics told 

Investors have begun dumping Chinese real estate stocks in fear of the possibility of weakening property prices due to potential fire sales of China Evergrande’s assets to fund repayment of debt.

Numerous sectors exposed to Evergrande impact

Property developing peers Country Garden Holdings has seen its shares slump over 19% this week to a near four-and-a-half month low. Shares in China Overseas Land & Investment has fallen over 9% and China Vanke has dropped over 10% this week. China Evergrande Group shares hit a near 12-year low on Friday.

Fitch Ratings said that numerous sectors could be exposed to heightened credit risk if Chinese property developer Evergrande were to default.

Smaller banks with higher exposure to Evergrande or to other vulnerable developers could face significant increases in non-performing loans, depending on how the Evergrande situation develops, Fitch Ratings said.

Orderly default needed

Singapore’s DBS Bank’s senior economist Nathan Chow has a similar view. “If Evergrande were to default, obviously some sectors will suffer from credit risk, such as smaller banks or smaller developers who have exposure to them,” Chow said at a webinar on Wednesday (15 September). 


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But according to both Fitch and DBS’ Chow, with a default inevitable, restructuring or liquidation should be done carefully. 

Fitch Ratings says the restructuring or liquidation of Evergrande assets must be conducted in an orderly manner in order to shield housing prices from the potential default.

Time for a haircut

Chow also suggested that the best way to deal with the situation is for Evergrande to restructure the debt. “The goal is to have an orderly wind down. In that case, a haircut is almost sure, but how much is the question? In the current situation, the most likely haircut will be 70-75%,” he added. 

According to Chow, the worst-case scenario is liquidation but that is a situation that no one wants. He said that the “ripple effects” of liquidation will be “far too big” for not just banks, but also homeowners.  

Analysts at Nomura said earlier in August that “markets should be prepared for what could be a much worse-than-expected growth slowdown, more loan and bond defaults, and potential stock market turmoil” due to headwinds faced by China’s “systemically important” property sector which contributed 16.4% to its GDP in 2020.

Commodity currencies hit

Meanwhile, according to Capital Economics’ Matthews, the negative impact of Evergrande’s default would be felt by commodity currencies. 

“Lower metals prices would, in turn, weigh on the currencies and equities of countries where their production is important, such as Australia and much of Latin America. These markets, we think, will be among the primary victims outside of China of the struggles of the country’s property sector,” he said. 

The effect was already visible in the Australian stock markets where the S&P/ASX 300 Metal & Mining index fell 4.6% to hit an over nine-month low. Iron ore and base metals prices extended losses over concerns on China’s property sector. ASX-listed shares in global miner Rio Tinto closed 4.6% lower at its lowest since 20 November. 

Chinese authorities to act

Capital Economics’ Matthews says, however, that investors should not panic as sooner or later he expects the Chinese authorities will intervene to support the market. 

“Although they may allow a temporary deterioration in broader financial conditions, China’s authorities would ultimately step in to stabilise domestic financial markets in the event of a large-scale default by Evergrande,” said Matthews. 

Additional reporting by Debabrata Das

Read more: Iron ore price dives further on China’s steel demand woes

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