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China’s next contagion

The risk of an Evergrande prompted contagion event has been speculated upon since August.

Let me start at the beginning, the Evergrande Group, one of China’s biggest private developers which employs hundreds of thousands of workers and supports construction firms and other contractors, is struggling under $300 billion in liabilities, including $20 billion in outstanding US dollar bonds. 

Just so we’re clear here, we’re talking about one company that has liabilities to the value of about 20% of the entire Australian economy.

If Evergrande defaults and bondholders are forced to sell other unrelated investments to raise cash, it may impact prices in seemingly unrelated markets – like Brisbane, where construction is rampant right now (just look at our skyline). 

Four ways Evergrande could impact our market

  1. An immediate risk to Australia is a potential slump in demand for iron ore. There has already been a 60% drop in the price of iron ore, which is one of our major exports to China.
  2. The price of raw materials to our construction sector, already rattled by Covid, could have one impact on Brisbane’s market. Some pundits are saying costs of those materials would go up, others predict it would go down due to a shift in supply demand. 
  3. Foreign purchasers might be impacted if China’s middle classes lose their investments; $58 billion’s worth of Evergrande’s debt is to retail investors, average Chinese people who may see their savings dissipate if those debts go unpaid.
  4. International students and Chinese migrants are central to the inner city unit market (the weak link in the housing market right now) in Brisbane, key for many investors. We might have fewer Chinese students and tourists returning when borders open up. 

How has this happened?

Evergrande has borrowed like crazy in recent years to help finance its rapid expansion, including building tonnes of residential developments across China to capitalise on the country’s hot property market.

Real estate activity is massive in China – it’s one-fourth of gross domestic product. But underneath that booming market are plenty of Chinese developers who have been in default of new debt ratio regulations, including Evergrande, following a crackdown on speculative real estate activity. It is thought that around 14 of China’s 30 biggest developers are in breach of the regulations, including the debt riddled Evergrande. Chinese financial regulators have warned Evergrande to resolve its debt issues without destabilising the property and financial markets.

So, what happens next?

In an effort to prevent the contagion, the Chinese State is said to be dismantling the giant developer slowly and behind the scenes, in what could amount to one of the biggest financial challenges their government has faced in years.

The plan, according to official government statements, is to sell off some Evergrande assets to Chinese companies while limiting damage to home buyers and businesses involved in its projects. But, Chinese authorities must do this without bringing down the country’s epic property boom.

I hope you enjoy the read.

Matt Lancashire