Evergrande’s problems: no systemic risk
Evergrande’s troubles cast doubt over the entire property sector, which accounts for over a quarter of China’s GDP. Recent events could weight on sentiment and lead to a further slowdown in construction-related activity. We recently revised down our Chinese GDP forecast for 2021 to 8.7% from 9.0% on covid disruptions and weakening data. For the moment, we are keeping that forecast unchanged, but recognise that there could be further downside risk.
We do not expect the authorities to ease their efforts to rein in leverage in the real estate sector, where liquidity has already been squeezed and credit problems have been rising. Despite official efforts to avoid contagion via injections into the financial system, ancillary sectors and companies are also under pressure.
A small number of mid-sized financial institutions have some meaningful exposure to Evergrande, but the Chinese banking sector’s exposure in general appears manageable at this stage. Western banks’ exposure would also seem to be contained.
Yield spreads for Chinese real-estate companies have risen steeply in credit markets, effectively closing many of them out of the market. Tensions have also risen in USD-denominated high-yield bonds in Asia more generally. But investment-grade credits are proving more resilient in China and in Asia at large. Chinese government bond yields and the renminbi have remained stable.
Real estate companies’ woes cloud the picture for China-related equity indexes. For example, until recently, the real estate sector was expected to supply 12.5% of the MSCI Hong Kong’s earnings growth next year. The risk of a systemic crisis, however remote, reinforces the relatively downbeat view we formulated in August when we argued that neither valuations nor earnings were likely to provide much support to offshore Chinese equities through to the end of this year.
Although we do not see a major risk of broad contagion at this stage, the Chinese authorities have little incentive to act pre-emptively, given they have long sought to reduce excessive risk-taking in the real estate sector. In other words, they are likely to wait and only intervene if it is truly necessary to ensure macroeconomic stability. Investors should therefore expect more bumps on the road to Evergrande’s probable restructuring.
To become more constructive on Chinese stocks, we would need to see more transparency surrounding Evergrande and decisive government intervention. More generally, we need to see improvements in the credit impulse, which could indicate better momentum in Chinese growth.