Weekly Brief: Evergrande’s A Serious Risk To The Global Financial System

Weekly Brief: Evergrande’s A Serious Risk To The Global Financial System

over 2 years ago3 mins

Evergrande was at the forefront of investors’ minds last week, as the potential collapse of the Chinese real estate giant looked like it might just bring global financial systems down with it.

🕰 Recap

  • House prices were soaring earlier this year, flashing indicators that the global housing market was in a bubble
  • By summer, the Chinese government was taking steps to cool down its own property market
  • Last week, investors started to focus on the impact that China’s real estate industry crackdown would have on property giant Evergrande
  • And with the Chinese property giant on the brink of bankruptcy, some investors worry the next financial crisis is on the horizon

✍️ Connecting The Dots

The Chinese government’s been cracking down on the country’s industries left, right, and center, and it’s all part of a drive toward “common prosperity” – essentially trying to make companies and markets fairer. So far, we’ve seen China hit the for-profit education and gaming industries, as well as tech companies with large banks of customer data.

China’s been doing the same to the real estate market: it’s been trying to make it easier for homebuyers to get on the property ladder by putting pressure on prices and rules in place to reduce the amount of debt in the sector. New limits prevent firms from having a liabilities to assets ratio above 70%, a net debt to equity ratio above 100%, and a short-term debt to cash ratio over 100%. And Evergrande – China’s biggest property developer – is failing on all three metrics, which means it isn’t allowed to borrow any more money. Mix in slowing or falling property price growth that reduces the firm’s income, and it has barely enough cash available to pay interest owed on its debts.

The obvious risk of Evergrande missing interest payments – a.k.a. “defaulting” – is already reflected in the dramatic drop in the company’s stock and bond prices. But last week, a deadline to repay $84 million worth of interest passed without Evergrande having confirmed payment. That prompted Credit Suisse – one of Evergrande’s biggest lenders – to reassure investors that its exposure to losses from Evergrande is limited, but too late: cue flashbacks to the global financial crisis…

🥡 Takeaways

1. China’s caught between two worlds.

The Chinese government has a tough choice: it could let Evergrande collapse into bankruptcy, but the damage to a real estate sector that represents 29% of China’s economy would probably tank hopes of an economic bounceback and hurt other industries. The alternative is to bail Evergrande out, but China would effectively be condoning the company’s risky, debt-laden behavior by saving it from any negative consequences. And given that the global financial crisis wasn’t that long ago, even more bailouts might be tough to justify.

2. You might want to start playing defense.

If Evergrande is allowed to fail, the aftereffects could reverberate all around China. So you might want to avoid Chinese stocks in the near term by and large, or potentially “buy the dip” on any long-term winners you’ve previously identified. And if Evergrande’s troubles spread globally and spark a selloff, many experts advise investors to buy “defensive” stocks in sectors like healthcare, utilities, and telecoms, where earnings and dividends are considered pretty predictable.

🎯 Also On Our Radar

German business survey data released on Friday indicated the country’s economy has been slowing down in September, which seems to be down to the same single factor that’s been affecting almost all countries and companies: clogged up supply chains. A lack of microchips – or, in the UK, truck drivers – has made it harder to get products made and delivered on time, if at all.

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