Potential Evergrande fallout to mostly impact China alone

Potential Evergrande fallout to mostly impact China alone

Financial distress at Evergrande has brought jitters in Emerging Market bonds — however, fortunately most of the impacts are limited to Chinese real estate bonds, where contagion from fall-out appears far-fetched.

2021 marks significant regulatory changes in China under the banner of “Common Prosperity Initiative” – targeting companies in Tech space, Real estate, and Education. The negative near-term implications from such regulatory actions have become more visible lately with Evergrande calling for debt-restructuring facing a possible default threat.

However, it compounded existing weakness precipitated by expected stimulus tapering by US Fed.

Moreover, the Chinese authorities are further escalating efforts on climate front with the latest being the country ending its support for offshore new coal power projects — unlikely to have material implications on coal prices which in the near term should persist to be a function of unwavering demand — while further actions are plausible with Beijing Winter Olympics beginning in February 2022 and on a much larger scale than seen in 2008 Beijing Summer Olympics.

Regions close to event sites are likely to face stringent climate protocols which include steel production hubs of Tangshan and Handan, refiners operating in the province of Shandong bringing concerns on production of fuels to the fore, and lastly Shanxi, Shaanxi, and Henan — home to coal mining with output curbs likely to further extend the rally in coal prices.

Moreover, output caps of steel and aluminum manufacturing are likely to be extended.

Evergrande — China’s second largest real estate player — has found itself in financial distress with latest numbers suggesting outstanding debt totaling $300 billion.

Evergrande aiming to meet compliance with new regulations which puts a cap on leverage of real estate companies has found itself grappling with liquidity shortfalls despite speeding up asset sales including listing of subsidiaries.

This has triggered pressure on EM bonds (JPM EMB ETF down 1.1% in the past one week) compounding existing weakness as investors digest stimulus tapering by the US Fed.

However, Evergrande announcement of settling $36 million interest payments on domestic bonds seems to have stabilized broader market jitters but only temporarily, where clarity is still needed on $83.5 million and $47.5 million bond payments due Thursday and next week respectively.

Furthermore, the aforementioned episode could result in liquidity implications across broader sector with a consequent impact on property development sales in the near term.

Evergrande episode is unlikely to form a contagion, at least for now, where Chinese authorities are mulling for an amicable resolution of the issue however, possibility of direct bailout is yet far-fetched. Hence, volatility shall persist in EM bonds space in the near term.

That said, spillover on commodities from the aforementioned developments is materially positive for regional steel players where scrap prices have already spiraled down by 2.4 per cent since the beginning of the month.

For cements, coal prices are likely to remain elevated in the near term however, lack of future investments in coal power plants by China is material positive.

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