China’s Evergrande crisis could inflict pain on the world economy
A liquidity crisis at a large Chinese property developer has shaken global markets, and strategists say it could send ripples across the global economy.
However, they say that it will be managed by the Chinese government and not spread to the global banking system.
The critical question for investors is how and when do leaders in Beijing handle the situation, and whether they launch a restructuring of China Evergrande Group as many market pros expect.
Beijing could let Evergrande fail and cause financial distress to stockholders as well as domestic bondholders. Evergrande faces a debt payment on its offshore bonds this coming Thursday, after it said last week it was facing unprecedented difficulties.
Jimmy Chang, Rockefeller Global Family Office’s chief investment officer said that everyone expected the government to find a solution because Evergrande was a highly systemic company. It has $300 billion of outstanding debt. China Evergrande must be resolved. This could lead to a contagion problem. It will likely end up with some state-owned, deep-pocketed enterprises that are able to takeover.
Although market pros do not believe Evergrande will cause the next financial crisis it may lead to greater volatility.
According to Rick Rieder of BlackRock, the chief investment officer for global fixed income, “The difficult part about China particularly is that it’s an opaque system so you often don’t get answers until you get them answers.”
Rieder also said, “The government tends to control the banking system.” There is a possibility of government intervention. If you combine this with everything else, I believe that there will be near-term financial questions about some property entities. This can lead to volatility and financial contagion. It is my belief that the government will react and it will stabilize.
According to Rieder, there may be caution for some time around multi-disciplinary Chinese companies and property companies.
It is possible that the slowing China economy will be further affected, and could cause ripple effects in other economies.
Chang stressed that the Chinese government must act fast since Evergrande began to have an effect on sentiment. This was after global markets ignored it.
This could turn out to be a selffulfilling prophecy. Real estate, and liquidity in general, are so crucial to China’s economy as well as the financial security of many Chinese families. Chang said that more than 90% of homeowners are home-owners. Many people invest in apartments. This could lead to a black swan.
Chang said that China’s large economy could have an impact on the rest of the globe. China Evergrande could cause serious economic problems in China, which would spread to the entire global economy.
The Dow Jones Industrial Average ended Monday’s trading session down more than 600 points, after steep stock market declines in Europe and Hong Kong and other parts of Asia. The 10-year Treasury yield, which moves opposite price, slid as low as 1.297% as investors sought safety in bonds.
Protecting the broader financial system
“I think ultimately the Chinese authorities will step in to make sure at least the wider financial system doesn’t run into crisis,” said Mark Williams, chief Asia economist at Capital Economics. The future for property developers is not bright. My key point is that policymakers will let property developers suffer great pain but they’ll also intervene to ensure the bank system works well.
Kynikos Associates founder and president Jim Chanos said that it is a crucial moment for China’s leadership. They have been imposing a strict regulatory regime on gaming, internet companies and education firms.
Chanos stated that it is crucial to watch how Beijing reacts to Evergrande.
“We’re seeing a shift in tone… The way that the government is treating western investors, business leaders, and businessmen. What will their approach be to a bailout everyone believes is imminent? CNBC interviewed him. Will Western bondholders get bailed? Is it going to only property owners who owe Evergrande apartments? Are banks going to take a haircut?
The Chinese property market is experiencing pain.
China attempted to curb speculation on its property markets four times, Chanos stated. “In all of these cases the economy reached stall speed quickly so the authorities took off their brakes and hit again the accelerator,” he stated.
According to him, China’s residential real estate market is 20% of China’s GDP and China’s overall GDP averages 30%. These numbers are not off the charts and have gotten worse since President Xi took office. Chanos who shorted Chinese stocks said, “We don’t think that it’s systematic to the Western Financial Markets.”
Williams, Capital Economics said that around 1.4million property owners have made deposits and are waiting to receive Evergrande properties. While we do not know for certain if the house owners can construct it, it is likely that they will. Williams noted that several residences are in various stages and some of them are under construction.
There is the risk that property values could drop if other companies have problems. This would cause turmoil on the housing market. Chinese consumers are a major part of the economy. A drop in housing costs could impact consumption.
This would cause a decline in Chinese imports and slowing demand for raw materials to spread into the other global and regional markets.
“When you couple it with some of the regulatory changes in China, the clear slowdown in growth, the clear slowdown in commodity demand alongside that growth, there’s some reason to pause and be patient about what’ happening in the region,” said Rieder. But China’s economic growth and its intertwined nature in the global economy are massive and will not stop being a major focus for the markets.