On Monday (Sept. 20), after days of seeming relaxed about property developer Evergrande, Hong Kong and US markets woke up to the idea there might be global ramifications to China’s $300 billion debt time bomb.
The developer is all but assured of defaulting on interest payments on bonds due Thursday, and China has been thus far silent about bailout plans. Hong Kong’s Hang Seng property index closed down 6.69% on Monday (Sept. 20) while the Dow Jones Industrial Average fell more than 600 points or about 1.8%. The S&P 500 closed down 1.5%.
It’s true that those banks and investors holding the developer’s roughly $19 billion of dollar-denominated bonds do stand to face substantial losses. But overall, as many analysts have pointed out, Evergrande’s debts are largely domestic, which means that the impact outside China, beyond those directly holding the bonds, is necessarily limited.
“One of the best ways to think about China is that it’s a country, but it operates like one large company. Yes, there are “private” banks in China and yes, there are “private” corporations, but in the end the Communist Party owns anything and everything (if it wants to). That’s the inherent danger of investment in China,” wrote Sevens Report Research president Tom Essaye in a note last week. “And because of that, there really isn’t global contagion risk with Evergrande because in the end, and as far as we know, the loans to Evergrande were made by Chinese banks that are implicitly backstopped by the Chinese government…the only way this would be a global systemic problem is if western banks were on the hook for Evergrande’s debts, which as far as we know isn’t the case.”
In today’s note, Essaye said he stood out by that stance, writing that Monday’s “outsized declines in stocks do not mean that the Evergrande saga deteriorated (it did not, at least not from where it was on Friday), and as such our opinion on Evergrande (that it’s a China problem, not a contagion problem) remains intact.”
S&P Global Ratings made a similar assessment in a web discussion on Monday Sept. 20.
“China is a largely domestically financed economy,” said S&P Global ratings analyst Kim Eng Tan. “Though it sells bonds offshore it is not a large amount.” He noted that if China had liberalized its financial markets, “foreign exposure would be a great deal more. In that case you worry about large foreign investors.”
Michael Pettis, finance professor at Peking University’s school of management, in a column for the Carnegie Endowment for the International Peace, also pointed to China’s tight controls over its financial system, which mean that the impact on credit markets is contained within China. And of the various problems Evergrande presents Chinese regulators, managing its own credit markets is likely to be the most clear-cut for China to address, he wrote:
The problem of contagion in the credit markets is straightforward, and Chinese regulators are in a very strong position to control it. Because the Chinese financial system is largely closed (meaning that the presence of foreign and independent creditors is very limited) and because the regulators are powerful and credible, they can quickly intervene and force a restructuring of liabilities to prevent the Evergrande contagion from causing a more general breakdown in the financial markets.
But that doesn’t mean that Evergrande’s situation isn’t a major problem for China, which has been trying to reduce risky debt, an effort that will face a setback if it intervenes here, as it is widely expected to do. Other aspects of the Evergrande problem will be hard to address, noted Pettis, such as the large amount of debt connected to China’s real estate sector, an oversupply of property, or a possible seizing up of the property market due to wary homebuyers and unpaid contractors declining to complete properties.
Coming back to Monday’s US stock market falls, these were also likely due to nervousness about the Fed’s upcoming moves and uncertainty about the global recovery from the pandemic. Hong Kong markets pared back some of their losses today, and US markets may do the same, suggesting that investors are rethinking their contagion concerns.
Then again, many analysts and investors didn’t forecast the enormity of the subprime mortgage debacle more than a decade ago, and its global repercussions. And last year, when early reports emerged of a new type of pneumonia in China, few of us could have thought we’d still be wrestling with it nearly two years later.