The likely default of the Chinese group Evergrande on its debts, including interest payments and debt obligations, has fueled fears of contagion spreading to global financial markets. The second largest real estate developer in China, Evergrande is a Fortune 500 company with over $ 300 billion in debt owed as of this week. Failure to pay such bonds could trigger a series of events that could lead to either the Chinese government’s bailout of Evergrande or a liquidation of the company’s assets that could spill over into various financial assets or have a domino effect. on banks and non-residents. banks with exposure to Evergrande, noted various market observers.
What’s going on in Evergrande?
Evergrande is a China-based real estate giant with 1.5 million residential units already sold but not yet completed, according to an Invesco note. The company’s presence is not limited to real estate, however. Evergrande has an automotive unit, an online media platform, a health food vertical, and even healthcare projects. With its sprawling activities, the conglomerate has a growing debt problem.
Right now, Evergrande has over $ 300 billion to repay investors, lenders and suppliers. “The total liability size of the Evergrande group is approximately $ 313 billion, which represents approximately 6.5% of the total liabilities of the Chinese real estate sector. In terms of total offshore bond outstanding, Evergrande Group has around $ 19 billion, which equates to around 9% of the total offshore bond market and 12% of the total offshore HY bond market, ”analysts wrote. ‘UBS in a note last week. This was around the same time that China’s Ministry of Housing and Urban and Rural Development told banks that Evergrande would not be able to meet its debt obligations which began yesterday.
Are Indian markets struggling?
Sensex and Nifty took a beating on Monday but seem fairly balanced so far on Tuesday. “The recovery of the Dow Jones, which fell 972 points low to close with a loss of 614 points, is an indication of the market’s confidence in the improbability of contagion. However, investors should be careful as the markets are richly valued and, therefore, vulnerable to corrections. The ultimate impact of the Evergrande crisis remains to be seen and known, ”said VK Vijayakumar, chief investment strategist at Geojit Financial Services. “There is another view that the Chinese crisis – the earlier regulatory crackdown and the Evergrande crisis – bodes well for India, facilitating increased capital flows to India. This can play out in the medium and long term, ”he added.
Global markets tumble
The fear of a default by the Evergrande group spreading across the world has forced a massive sell-off in global markets, including India. On Wall Street, the Dow Jones fell 1.78% on Monday while the S&P 500 fell 1.7%. While the Chinese stock exchanges are closed for a holiday today, Hang Seng is down 3.5% since the end of last week. Likewise, the Japanese equity indices Topix and Nikkei 225 are down more than 1.5% each. Hong Kong-listed Evergrande has already plunged 16.4% this week. The title is down 84.5% since the start of the year.
The spillover also caused Dalal Street to crash, falling nearly 1% yesterday as domestic steel stocks took the heat. Also today, Sensex and Nifty were under pressure, trading in the red.
Could Evergrande cause a massive sell-off globally?
“Although our baseline scenario is now that a credit event for Evergrande seems inevitable, the extent to which we spill over into other markets will depend on the restructuring or complete liquidation of Evergrande,” the report states. ‘UBS. They added that the restructuring of liabilities is much more plausible.
Liquidation and its consequences
In the event of Evergrande’s liquidation, if investors get extremely low salvage values, it would cause a significant loss of investor confidence in the wider real estate sector / Asian HY offshore market and create spillover effects on Chinese financial assets in China. wider. “We believe this could also lead to a reassessment of the risk premium in global credit markets, with emerging markets underperforming the DM and HY-IG decompression in both USD / EUR markets,” UBS said.
In addition, in the event of a liquidation, UBS expects a domino of credit events as banks and non-banks with significant exposures to Evergrande could potentially go bankrupt or be forced to restructure. UBS added that Evergrande’s commitments could involve more than 130 banks and more than 120 non-bank institutions. “Evergrande’s total debt exposure in the first half was RMB 834 billion – made up of RMB 633 billion in loans and RMB 200 billion in offshore bonds and other debt. This means that Evergrande’s debt represents around 2-3% of the Chinese bank’s Tier 1 base capital, which was around 18.5 trillion at the end of the second quarter, ”Invesco analysts said in a note.
If the Chinese government does not step in to help Evergrande, UBS expects rating agencies to change their methodology and remove multiple rating hikes and state support assumptions in non-real estate sectors, at the same time. both in the offshore US dollar market as well as in the
onshore market. “This could cause additional selling pressure and lead to significant liquidity distortions in China’s offshore and onshore bond markets, with the potential to spill over into emerging market credit, as several emerging market credit accounts tend to hold Chinese offshore bonds as part of their Asian HY. exhibition, ”they added.