Evergrande, one of the largest Chinese property developers, has been under pressure over concerns that it may be technically insolvent if its large land and real estate portfolio was marked to market. With some US$ 305 billion in liabilities, concerns are mounting that the default of Evergrande could send shockwaves across the Chinese economy. Other property developers have traded significantly lower alongside Evergrande. Evergrande has been a cause for concern for several years. It first vowed to reduce debt back in August 2017. The People’s Bank of China (PBoC) has been aware of the risk posed by Evergrande for several years, noting in November 2018 that it posed a systemic risk to the domestic financial system. Despite the significant impact that a disorderly resolution for Evergrande could have on Chinese debt and equity markets, there is relatively limited overseas exposure. CreditSights has estimated that there is only US$ 7.4 billion in direct overseas debt exposure to Evergrande bonds. Due to restrictions for foreign companies on investing in the equity of Chinese financial firms, there is little to no reported equity exposure held on balance sheet for major banks and insurers.
Our View
The lack of international exposure to Evergrande means that there is no clear risk that issues surrounding Evergrande will lead to a global financial contagion. The disorderly bankruptcy of Evergrande could lead to domestic financial contagion in China, the type of hard landing that FrontierView has noted in our Events to Watch report series. This would certainly lead to negative growth revisions for countries and companies that rely on Chinese imports. But even this stress-test scenario is unlikely to cause significant issues for the global financial system, given the limited leverage and direct equity exposure of Western banking systems to Chinese financial companies. Going beyond the stress-test scenario, our China team believes that Chinese leaders will step in to stabilize the real estate market and developers to limit the impact to the domestic economy, further reducing the likelihood that some sort of global risk event occurs.
Business Implications
Firms with significant domestic operations in China, particularly those tied to the property sector, need to revisit their short-term and medium-term demand plans. China has been taking steps in recent years to reduce its reliance on the property sector to generate growth, and this will continue and likely accelerate in the coming years due to this episode with Evergrande.
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