The trials and tribulations facing China Evergrande Group (HKSE:03333, Financial) have only recently begun making international headlines, gaining the attention of investors and market watchers worldwide. Yet, as I discussed in July, the crisis facing China’s largest property developer is far from sudden; rather, it is the culmination of a disaster years in the making.
Still, the speed of the collapse has only accelerated. A lot has changed even since August, when last I discussed the situation. With Evergrande’s financial implosion continuing apace, focus has shifted away from the particular fate of the once-mighty property titan and toward issues of macroeconomic impact, especially the risk of significant domestic – and even global – financial fallout.
Chinese markets brace for impact
China’s debt markets have in recent months been roiled by a cascade of defaults and near-defaults. As the Financial Times reported on Aug. 23, this trend has shaken confidence in Chinese debt markets, especially among foreign investors with high exposure and limited recourse:
“Since late last year, China’s $17.5 [trillion] bond market has been rocked by a rising number of defaults. This has focused attention not only on policymakers in Beijing, but also foreign investors who hold about $850 [billion] in dollar-denominated Chinese corporate debt.”
Evergrande certainly stands out from the pack of severely leveraged domestic companies thanks to the sheer scale of its debt crisis, but it is hardly an isolated case. However, its particular troubles are reflective of the acute financial weakness apparent among many of China’s largest property developers. Investor anxiety about the sector has only intensified in recent months. As Edmund Goh, investment director at Aberdeen Standard Investments, observed on Aug. 30, weakness among property developers such as Evergrande has undermined confidence in Chinese high-yield debt:
“I would think that most of the weakness is contributed by the property developers. If Evergrande moves then it will have a pretty sizeable impact.”
Contagion fears spread
Fear that Evergrande’s failure could trigger a broader financial crisis has been increasingly magnified. Indeed, the specter of contagion has reared its ugly head with growing frequency. Thus far, the Chinese government under President Xi Jinping has responded aggressively to the nascent crisis.
According to a report last week by Societe Generale SA (XPAR:GLE, Financial) economist Wei Yao, the Chinese government has flooded the market with liquidity in an effort to stave off a catastrophic systemic meltdown:
“Avoiding a systemic liquidity squeeze is the absolute priority for the PBOC and it has means to do so. A Lehman-style financial-market meltdown is not our top concern, but an extended and severe economic slowdown seems more probable."
Liquidity injections can help buoy financial markets, but their power to affect macroeconomic levers is more limited. That could prove problematic in light of the marked slowdown in the Chinese economy seen in August, an ominous sign that has only added to the anxiety.
Staving off global financial shock
Whether any domestic financial contagion could spread meaningfully beyond China’s border remains an open question. Concerns that China’s crisis could spill over into other markets have manifested in shifting behaviors among international companies. In the United States, for example, corporate bond issuance has fallen off markedly in recent days, as Bloomberg reported on Sep. 20:
“Corporate America put the brakes on a month-long borrowing binge on Monday as growing concern about spillover effects from property developer China Evergrande Group roiled markets globally. At least eight blue-chip companies that had planned to sell bonds decided to stand down, underwriters said. Worries about Evergrande pulled down equities around the world, including about a 2% decline in U.S. stocks. A key barometer of high-yield investors’ risk aversion, the Markit CDX North American High Yield Index, weakened.”
While there are clearly signs of rising anxiety in international credit markets, it appears that most investors have remained sanguine about the risks thus far. The fact that China’s financial markets are still comparatively insular may help to limit the spread of financial contagion somewhat, in my view.
However, if China’s economy also sags substantially in the face of an historic corporate debt crisis, the impact could well be felt worldwide.
