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Chinese policymakers faced with 'moral dilemma' to avoid property crisis contagion

Residential sales to fall 10% next year

Authorities in China are faced with a “moral hazard dilemma” as they manoeuvre to contain the economic fallout from the country’s evolving real estate crisis. Still, a Lehman Brothers-like scenario sparked by Evergrande is seen as “unlikely”.

Nevertheless, Chinese real estate developers are heading for a "tough" 2022, according to recent analysis by S&P Global Ratings. In a worst-case scenario, one third of China's developers may see their liquidity "acutely strained", while defaults are set to rise as $84bn of debt matures over the next five quarters, according to the report.

Meanwhile, China's residential sales are forecast to decline by 10% next year, and a further 5%-10% in 2023.

Klisman Murati, CEO of research firm Pareto Economics, said: "A slowdown in the Chinese housing market in both supply and demand could lead to broader unemployment and a drop in the Chinese stockmarket for sectors involved.

"This could then easily spread through global trade routes and be bad news for the mining and metals complex internationally, as China is a huge buyer of commodities."

Against the backdrop of China's economic growth slowdown, an ongoing regulatory crackdown seeks to keep any contagion from spreading beyond the country's beleaguered real estate industry.

For President Xi Jinping - whose expressed desire to promote "common prosperity" over GDP coincided with a change in the regulatory environment - the country's property sector is arguably too big to fail.


"As one of China's largest property developers, Evergrande's size and precarious financial position pose real risks for China's authorities, economy and financial markets," Maria Negrete-Gruson, portfolio manager of the Artisan Partners Sustainable Emerging Markets fund, told Investment Week.

However, she added, Evergrande is "unlikely to spark a Lehman type moment - if China's authorities properly manage the situation".

Evergrande's debt troubles have galvanised broader issues at play in the sector, placing it under increased scrutiny. The situation is endemic - other developers such as Country Garden and Kasia are feeling the squeeze too.

In Evergrande's case, Chinese authorities reportedly told chair Hui Ka Yan to use his personal wealth to pay back bondholders.

Citing anonymous sources, Reuters reported last Tuesday (16 November) that Hui has been freeing up funds from luxury assets such as art, calligraphy and three properties to help pay the company's dues.

Patrick Ge, Morningstar manager research analyst, highlighted that Evergrande's coupon payment of offshore dollar bonds - barely meeting the deadline of its 30-day grace period - "saved the company from a default".

"While this provides some short-term relief to market sentiment, it does not mean that Evergrande has turned the corner," he added.

On Thursday (18 November), S&P said a default was still "highly likely" as the firm faces maturities worth $3.5bn in dollar bonds in March and April next year, while total liabilities exceed $300bn.

Evergrande's share price continued to slide last week as the developer scrambled to sell off assets - including an 18% stake in streaming services firm HengTen at a loss of more than $1bn.

Government intervention

Seema Shah, chief global strategist at Principal Global Investors, said: "Policymakers face a moral hazard dilemma: They want to punish reckless speculative behaviour, but they are really sensitive to the need to avoid the wider financial and economic risks posed by a collapse of Evergrande."

Spanish insurer Mapfre's chief economist Alberto Matellan highlighted that the CCP has a "firm grip" on the country's economic circumstances.

He argued that Europe is "suffering the most" from the Asian superpower's economic deceleration.

For Shah, the financial risks posed by the Chinese property crisis "will not spiral out of control" as long as regulators can "break the self-reinforcing feedback loops between developers and banks".

Yet concerns about China's regulatory environment and the "possible contagion from the Evergrande property crisis lurk in the background as potential risks", according to Joe Bauernfreund, manager of AVI Global Trust, which has cut exposure to the country.

Even the US Federal Reserve highlighted China's property crisis as a potential risk to global financial stability earlier in November.

High leverage

Jack Tsai, credit portfolio manager at Hong Kong-based asset manager Chartwell Capital, said: "The real estate cooling measures implemented by the Chinese central government have disproportionately affected the highly leveraged property development companies."

Evergrande has always been a "poster child" for high leverage and high risk, he added.

Tsai noted that nearly all non-state-owned property developers are facing "a crisis of investor confidence" as seen in the two-month long sell-off in the sector's bonds.

In September alone, investors pulled over €232m from Europe-domiciled China bond funds, the latest data from Morningstar shows.

Pareto's Murati highlighted: "It is the offshore bonds that have non-Chinese investors worried as these are the bonds they have exposure to."


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