Mounting problems at China Evergrande , the hugely indebted Chinese property developer, are rattling global financial markets as investors worry about the potential for an Asian reprise of the U.S. financial crisis of more than a decade ago.
The disturbing parallel on many minds is the collapse of the U.S. investment bank Lehman Brothers Holdings Inc. When Lehman Brothers, a major holder of subprime mortgage debt, filed for bankruptcy on Sept. 15, 2008, the global financial system froze and stock markets plunged.
In a distant echo of that ugly day, global markets swooned on Monday as Evergrande’s problems came into sharp focus ahead of a crucial payment deadline on Thursday. The benchmark S&P 500 index of large U.S. companies lost 1.70 per cent, while in Toronto the S&P/TSX Composite slid 1.64 per cent.
Evergrande, a sprawling corporate octopus with hundreds of development projects under way across China, owes the equivalent of more than US$300-billion, an amount equal to roughly 2 per cent of Chinese gross domestic product. The giant developer has become a symbol for China’s debt-fuelled real estate addiction, which bears some disturbing resemblances to the U.S. housing mania of the early 2000s.
Rumours of Evergrande’s financial problems started surfacing a year ago and investors have grown increasingly concerned about the company’s future. This week, the developer faces the daunting task of paying interest equal to more than US$100-million. A default of some kind “appears probable,” credit-rater Fitch warns. Some Evergrande bonds denominated in U.S. dollars are already trading below 30 cents on the dollar, indicating that investors are expecting heavy losses.
“Evergrande has the potential to be the largest corporate debt default ever, with spillovers to other financial institutions, Evergrande’s suppliers, homeowners, wealth product holders, other property companies, and onward and outward,” warned Alan Ruskin, a macro strategist at Deutsche Bank, in a note Monday.
But for now anyway, many expert observers play down the Lehman comparison. Even if Evergrande defaults, it is unlikely to set off a similar wave of financial contagion, they insist.
“The [Chinese] property sector is a mess and, no question, more pain is coming,” said Leland Miller, chief executive officer of China Beige Book, a private analytics firm that tracks the country’s economy. “But there is no real risk of wider contagion because China is fundamentally a non-commercial financial system.”
Beijing can order Chinese lenders to lend to whomever the government deems appropriate, and force counterparties to do business with whomever the government chooses, Mr. Miller said in an interview. For that reason, he sees no danger of an economy-wide freeze on lending and financial transactions such as occurred in the United States after Lehman went bust.
Jonas Goltermann, senior markets economist at Capital Economics in London, offered a similar view. “Our base case is that fears of China’s Lehman moment will prove overdone,” he wrote in a note Monday.
While “China’s financial markets are increasingly bracing for a property market bust,” he said, the contagion effects will be limited because the stresses on Evergrande are, in large part, the result of a deliberate campaign by Beijing to bring real estate euphoria back to earth by tightening credit for developers. The Chinese government will act swiftly to limit the pain felt by ordinary households and other developers, he asserted.
Still, there are dangers, both Mr. Miller and Mr. Goltermann agreed. Among other concerns, the Evergrande tumult underlines the increasingly unpredictable decision-making in Beijing. President Xi Jinping and the ruling Communist Party have cracked down brutally on many of China’s leading technology companies in recent months, leading to major declines in the stock prices of one-time high fliers such as Tencent and Alibaba.
Mr. Miller said that Mr. Xi and the Chinese Communist Party are shifting their domestic message away from a simple emphasis on economic growth at all costs to a more nuanced approach that also promises to address growing inequality within China.
Part of that shift involves taking a tougher line with the property sector, which has generated big growth over the past decade but at the cost of soaring debt.
Beijing’s new strategy may ultimately result in a healthier economy, but in the short term it nearly certainly means painful disruption and slower growth for China, Mr. Miller warned.
Judging from Monday’s global selloff, that is not a welcome message for investors already concerned about inflationary pressures, lofty stock market valuations and continuing lockdowns.
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