Why China’s Evergrande is causing anxiety in global markets with the possibility of a default on debt

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Growing problems in China Evergrande, the highly indebted Chinese property developer, are plaguing global financial markets as investors worry about the prospect of an Asian resurgence of the US financial crisis from more than a decade ago.

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A disturbing parallel to many minds is the collapse of US investment bank Lehman Brothers Holdings Inc. When Lehman Brothers, a major holder of subprime mortgage loans, filed for bankruptcy on September 15, 2008, the global financial system froze and stock markets collapsed. .

In a distant echo of that ugly day, global markets swooned on Monday as Evergrande’s problems surfaced sharply ahead of a crucial payment deadline on Thursday. The benchmark S&P 500 index of major US companies fell 1.70 per cent, while the S&P/TSX Composite in Toronto fell 1.64 per cent.

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Stocks close down sharply as Evergrande solvency fears rock already volatile markets

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Evergrande, a giant corporate octopus with hundreds of development projects across China, is worth more than US$300 billion, which is equivalent to about 2 percent of Chinese GDP. The giant developer has become a symbol of China’s addiction to debt-fueled real estate, which bears some disturbing resemblance to the US housing craze of the early 2000s.

Rumors of Evergrande’s financial problems began to surface a year ago, and investors became concerned about the company’s future. This week, the developer is faced with the daunting task of paying interest equivalent to over US$100 million. Some kind of default “appears to be probable,” warns credit-rater Fitch. Some Evergrande bonds denominated in US dollars are already trading below 30 cents on the dollar, indicating that investors are expecting heavy losses.

Deutsche Bank macro strategist Alan Ruskin warned, “Evergrande has the largest corporate loan default ever, with spillovers to other financial institutions, Evergrande’s suppliers, homeowners, wealth product holders, other property companies, and on and off.” has the potential to be.” , in a note on Monday.

But for now, many expert observers play down Lehmann’s comparisons. Even if Evergrande defaults, it is unlikely to set off a similar wave of financial contagion, they insist.

“NS [Chinese] The 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 widespread infection because China is basically a non-commercial financial system.”

Beijing could order Chinese lenders to lend to the government as it deems fit, and force counterparties to do business with the government, Mr Miller said in an interview. For this reason, they see no threat of an economy-wide freeze on lending and financial transactions such as happened in the United States after the bust of Lehman.

Jonas Golterman, senior market economist at Capital Economics in London, offered a similar view. “Our ground case is that China’s Lehman moment will be over,” he wrote in a note on Monday.

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While “China’s financial markets are gearing up for rapid property market turmoil,” he said, the contagion effect will be limited because tensions on Evergrande are, in large part, the result of a deliberate campaign by Beijing to bring back real estate enthusiasm. . Earth by hardening credit to the developers. He stressed that the Chinese government would act swiftly to limit the pain felt by ordinary homes and other developers.

Still, there are dangers, both Mr. Miller and Mr. Golterman agreed. Among other concerns, the Evergrande turmoil underscores the increasingly unpredictable decision-making in Beijing. President Xi Jinping and the ruling Communist Party have brutally cracked down on several of China’s major technology companies in recent months, causing major drops in the stock prices of one-time high-flyers such as Tencent and Alibaba.

Mr Miller said Mr Xi and the Chinese Communist Party are shifting their domestic message 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 change involves taking a hard line with the property sector, which has seen huge growth over the past decade, but at the cost of rising debt.

Beijing’s new strategy could ultimately result in a healthier economy, but in the short term it will almost certainly mean painful disruption and slow growth for China, Mr Miller warned.

Given Monday’s global sell-off, this is not a welcome message for investors who are already worried about inflationary pressures, elevated stock market valuations and continued lockdowns.

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