Research China: The Evergrande situation and what we expect

Danske Research Team Danske Bank A/S

Bottom line: We expect the turmoil related to Evergrande to get worse before it gets better. But we believe the Chinese government will eventually intervene as the alternative could be a financial crisis with very severe effects on the Chinese economy and the Chinese people. The government needs to strike a balance between on the one hand show that irresponsible behaviour has a price and reduce moral hazard issues in the credit market and on the other hand not allow a financial crisis to unfold. The Chinese mini-crisis adds another headwind to Chinese growth this autumn.

Background

The Chinese property sector is around 25% of Chinese GDP if both directs effects from construction as well as indirect effects from upstream and downstream industries included. The developer market is highly fragmented with many players. Evergrande is the second largest developer but only has a total market share of 4%.

Some developers, including Evergrande, have very high debt levels after many years of expansion and some of the companies used very creative financing tools as supplement to normal debt and bank loans. Most of the debt is domestic but offshore bonds have also been issued. Evergrande has debt worth USD300 bn equivalent to 2% of Chinese GDP.

After many years of growing debt levels, China put fighting financial risks on top of their agenda five years ago. In 2020 they tightened rules for developers putting limits on the debt and increasing requirements on liquidity (the so-called “three red lines” regulation).

The new regulation has created challenges for the most leveraged developers. Evergrande is one of them. When the housing market cooled down significantly this year after policy tightening, Evergrande has faced a liquidity crisis. For more info on Evergrande see box below.

On top of bank loans and issuance of bonds some financing for developers are through Wealth Management Products sold directly to Chinese citizens. There is a rising risk that they will start redeeming their money when possible and thus cut off a funding channel. Losses on these products could also lead to widespread protests.

How bad are markets hit?

Chinese stock markets have taken a big hit with offshores equities trading close to lowest levels in six years. Developer stocks have declined significantly over the past week and high yield financing costs are the highest in a decade at 14%. We believe the domestic contagion has reached a point where intervention from Beijing is needed to stop the snowball that has started to roll.

Until this week contagion to global markets has been limited but in recent days global risk sentiment has been hit. S&P500 dropped 1.7% on Monday.

Download The Full Research China

Author

Danske Research Team

Danske Bank A/S

Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.

EUR/USD stays defensive below 1.1900 as USD recovers

EUR/USD trades in negative territory for the third consecutive day, below 1.1900 in the European session on Thursday. A modest rebound in the US Dollar is weighing on the pair, despite an upbeat market mood. Traders keep an eye on the US weekly Initial Jobless Claims data for further trading impetus.

GBP/USD holds above 1.3600 after UK data dump

\GBP/USD moves little while holding above 1.3600 in the European session on Thursday, following the release of the UK Q4 preliminary GDP, which showed a 0.1% growth against a 0.2% increase expected. The UK industrial sector activity deteriorated in Decembert, keeping the downward pressure intact on the Pound Sterling.

Gold sticks to modest intraday losses as reduced March Fed rate cut bets underpin USD

Gold languishes near the lower end of its daily range heading into the European session on Thursday. The precious metal, however, lacks follow-through selling amid mixed cues and currently trades above the $5,050 level, well within striking distance of a nearly two-week low touched the previous day.

Cardano eyes short-term rebound as derivatives sentiment improves

Cardano (ADA) is trading at $0.257 at the time of writing on Thursday, after slipping more than 4% so far this week. Derivatives sentiment improves as ADA’s funding rates turn positive alongside rising long bets among traders.

The market trades the path not the past

The payroll number did not just beat. It reset the tone. 130,000 vs. 65,000 expected, with a 35,000 whisper. 79 of 80 economists leaning the wrong way. Unemployment and underemployment are edging lower. For all the statistical fog around birth-death adjustments and seasonal quirks, the core message was unmistakable. The labour market is not cracking.

Sonic Labs’ vertical integration fuels recovery in S token

Sonic, previously Fantom (FTM), is extending its recovery trade at $0.048 at the time of writing, after rebounding by over 12% the previous day. The recovery thesis’ strengths lie in the optimism surrounding Sonic Labs’ Wednesday announcement to shift to a vertically integrated model, aimed at boosting S token utility.