Evergrande issue unlikely to be systemic

Even though China may allow Evergrande and other developers to fail, the Chinese economic system is ultimately underwritten by the government and should not collapse as bearish investors fear.

With the Chinese real estate giant heavily indebted and the Chinese government cracking down on real estate debt, Evergrande was forced to sell properties at a discount to generate cash. At the time of writing (24 September), many Australian investors were looking at falling iron ore exports as a result of reduced steel production for Chinese construction meaning the potential ramifications on Australia’s economy were unclear.

Platinum deputy chief investment officer, Andrew Clifford, told investors there was unlikely to be a domino effect because China had been focused on reforming its financial sector in recent years which reduced the risk of the failure having a widespread domino effect.

However, he admitted, some individuals and corporates would be impacted “as that is the nature of corporate lending”, but it was important to remember China had not experienced the rampant asset price boom seen in most parts of the world.

Reuters reported Evergrande’s US dollar bondholders were still waiting for information about a US$83.5 million ($114.3 million) interest payment which had been due on 23 September – this was now expected to be delivered in the coming month. A further US$47.5 million US-dollar-bond interest payment was due this week.

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According to Janus Henderson’s lead emerging markets analyst, Jennifer James, current market pricing estimates indicated Evergrande’s US-dollar bond holders were likely to recover very little, with no expectation of a coupon. The most likely outcome, according to James, was the company engaging with creditors to come up with a restructuring agreement.

James said so long as the Chinese government did not mishandle the situation, there would not be contagion effects on other markets.

“However, if the government opts not to use tools to engineer a soft landing for Evergrande – e.g., the government does not step in to ensure that the estimated 1.6 million homes paid for but not yet delivered are built – then there could be a crisis,” she said.

Though there was a risk a slowdown in property market activity could spill into the real economy and cause short-term market disruption, Clifford said Evergrande did not represent trillions of dollars of inflated assets with non-serviceable interest.

“It is a property developer with developed and undeveloped land, hence it has collateral. It is relatively straightforward to assess, value and/or liquidate,” said Clifford.

With Evergrande agreeing to settle interest payments on a domestic bond and China’s central bank injecting cash into the banking system, AMP chief economist, Shane Oliver, said he believed China was unlikely to allow the failure to “mushroom” into a credit squeeze.

“While the Chinese authorities want to teach property developers and investors a lesson about the dangers of too much debt, it’s unlikely to allow Evergrande’s failure to mushroom into a full-on credit squeeze or a ‘Lehman moment’ that collapses the property sector (via forced property sales) and the economy.

“So ultimately, some sort of debt restructuring rather than full bankruptcy is likely.

“And more broadly China is likely to provide policy stimulus to support growth into year end.”

David Bassanese, chief economist at BetaShares, said: “The issue is whether Evergrande will manage to meet scheduled interest payments, formally default, or somehow be bailed out by the Government. So far at least, global financial contagion remains contained – helped by the fact it is mainly Chinese creditors at risk”.