Evergrande weighs on Chinese debt markets, but global contagion limited
Ever since Evergrande, China’s second largest property developer, announced that it missed its bond payments, the Chinese debt markets have been in a turmoil. Bond prices have slumped and its effect in the $5 trillion real estate sector is causing investors billions of dollars in losses. Several other Chinese real estate companies are faced with a severe cash squeeze.
Some high-yielding Chinese real estate bonds yields have slumped some even more than 75% showing that the financial difficulties run deep. This has been further aggravated by the fact that the Chinese property prices have slowed considerably in recent times.
Property curbs
The Chinese government has been trying to curb the overheating in the real estate sector for some time now by regulating the leverage levels of property developers. Since then, Evergrande has been scrambling to pare down debt levels, selling stakes in subsidiaries and offloading properties at discounted prices.
The property binging spree that started several years ago, saw Evergrande, the biggest and one of the most indebted real estate companies in the world with near $300 billion in debt, triple its borrowings in the last five years. The firm amassed large land reserves over many years to build scale in its real estate business banking on the rising property asset values and increasing sales for liquidity.
However, ever since the Chinese government cracked down, curbing leverage, real estate players have been scrambling for liquidity.
Containing the contagion
For now, restricting this crisis to the real estate sector will be paramount. A large portion of Evergrande’s borrowings and bond issuances are in the form of domestic debt, while about $20 billion is in the form of foreign currency debt, held by overseas investors. With much of the debt local, a global contagion can be ruled out.
Notwithstanding, the worries over the possible spiralling effects of a debt crisis has driven the Chinese high-yield spreads to record highs. Investment grade spreads have also widened to the highest in two months as many warn that a disorderly correction in the property market could hit the personal wealth of homeowners. Further, it may be worth pointing out that if is not contained with intervention by the Chinese government, it could spill over to other sectors of the Chinese economy. Any failure by Evergrande to restructure its debt with creditors could even lead to liquidation that could send the domestic Chinese debt market into a tailspin with possibly spill-over effects on the financial system.
Contagion risks include supply chains, which in turn include commodities, vendors and even Chinese home buyers. Credit risks issues could get aggravated if not checked quickly as the government has been tight-lipped about the situation. The Chinese Central Bank, however, continues to pump in liquidity keeping the situation under control.
A Chinese government intervention is probably the most likely path forward given the circumstances. One reason is that real estate comprises of a large portion of the Chinese investors’ assets. Household savings of about 66% of Chinese wealth is invested in real estate.
Hence, the odds for the moment are that China avoids a default scenario as it could lead to a severe liquidity crunch. A similar situation in India involving infra-lending institution IL&FS led to tightening in domestic liquidity, particularly for a large number of non-banking financial institutions.
Domestic tailwind gains
For now, the crisis in China does may not pose a risk for Indian markets apart from heightened volatility that accompanies such situations. However, commodity markets could witness bouts of choppiness given China’s hefty weighting on the global commodity markets.
The positive fallout is that it could cause a pause in commodity-led inflation, which has been a dampener for several Indian sectors. This could also lead to lower inflation, but these are still early days.
Globally, debt markets will be bracing for turmoil, and some of that could lead to rate increases. However, the larger risks emanating from rising rates may be some time away as the US Fed has already announced that it will keep rates at low levels for the next two years.
Overall for the Indian economy, the Evergrande crisis in China could give further impetus to the China + 1 policy that several global producers have been shifting to lately, which could benefit India. The other benefit that India could see is increased global capital inflows if confidence in the Chinese market wanes.
All in all, for Indian investors, there appears be less systemic tail risks, while the scales appear tilted toward tailwind gains.