Is the Evergrande Debt Crisis China’s Death Knell?

Was the coronavirus pandemic the beginning of the end for China’s 21st-century economic dominance? Before the COVID-19 public health crisis, Beijing maintained plenty of gaping holes in the titanic, forcing the central authorities to print money to plug these cavities. However, in the aftermath of the once-in-a-century global health calamity, everything that had been left to sink to the bottom of the Nanhai is rising to the surface, potentially triggering a tsunami that would flood the global financial markets. Not even a keg of baijiu will be enough to drown the international economy’s sorrows should China fall to its knees.

China’s Lehman Brothers Moment

There is one name dominating international business headlines: Evergrande.

The quarter-century-old real estate development juggernaut has created woeful conditions on Wall Street, the London Stock Exchange, and the Toronto Stock Exchange. Investors have been hitting the sell button on the possibility of Evergrande crumbling over its enormous $300 billion in liabilities. The company is believed to be poised to miss fundamental interest and principal payments, signaling that the firm is on the brink of default. China is attempting to limit the fallout of the organization’s impending doom by injecting the financial system with $18 billion – and counting – in liquidity. It is unclear if the central authorities will bail out the oft-described “too big to fail” entity, but the consensus among market analysts is that President Xi Jinping would only approve a bailout package if Evergrande’s collapse contains far-reaching contagion. Until then, traders are clenched and waiting for the dominos to fall the equities arena.

The EV Boom Goes Bust?

Across the globe, one of the biggest markets is the electric vehicle. Most major automakers, such as Ford and General Motors, have hopped on the bandwagon, hoping to replicate Tesla Motors’ success. China was meant to be a prominent leader in this sphere, with a diverse array of companies hoping to dominate domestic and foreign markets. However, like the deserted cities that were meant to become the hubs of prosperity, electric car factories have metastasized into wastelands, with many of them sitting empty.

A growing number of these businesses have either gone bankrupt or became zombified. With Xiao Yaqing, China’s minister for industry and information technology, Beijing has now intervened, telling reporters that "we have too many EV firms." The state will manage resources, introduce stricter regulations, and adjust lending rules. But China is not giving up its dreams of becoming an EV powerhouse. Instead, the government pledged to enhance its charging network and facilitate greater electric car sales in rural markets.

More Cracks in the Bond Market

While the world focuses on Evergrande, another Chinese developer's suite of bonds is facing intense selling pressure. According to new data from Bloomberg, Sinic Holdings Group has seen its dollar bonds crater following a credit downgrade and a drop in share prices. On Oct. 18, Sinic's $246 million bond will be due, and financial experts are worried of "substantial risk" about its "concrete repayment plans" failing to be installed.

This would be another high-profile leveraged business to endure financial pressures. At the end of 2020, international markets were aghast when Yongcheng Coal & Electricity Holding Group, a state-owned mine operator in the Henan province, could not complete a principal or interest payment on AAA-rated commercial paper worth nearly $152 million.

Indeed, bonds have been surging, particularly junk-rated dollar bonds, which have soared to their highest yields in a decade. These types of bonds typically offer investors higher rates because of the enormous risk inherent in these securities. Of course, it is a Faustian bargain at this point: The more significant the yield, the higher the risk.

Local Government Debts

And then there are the mounting local debt levels beginning to creep into the news headlines. The Central Government has initiated tighter supervision over local government financing vehicles (LGFVs), leading to speculation that municipalities cannot locate enough funds to repay their debts. U.S. rating agency Moody's Investors Services warned that local governments would likely increase their commercial exposures to generate better cash flows. Some cities might also tap unconventional borrowing instruments, such as lending capital from shadow banking outfits.

It is estimated that local government hidden debts, including bonds and loans, total $6.95 trillion as of the end of last year. This is equal to approximately 44% of China's gross domestic product (GDP).

The Dragon’s Fire Breath Has Been Extinguished

When President Xi liberalized China’s financial markets and allowed foreign investors into the fold, there was a method to the madness. While it was a component of former President Donald Trump’s trade war and subsequent deal, the nation had been desperate for an injection of fresh capital. Indeed, the maneuver has been working as foreigners have been pouring into Chinese debt, purchasing record amounts of local government bonds this past summer. But how much longer can Beijing maintain the charade? Whether it is Evergrande or Sinic, this is quite possibly the beginning of the end of China's massive bull run this century. The Red Dragon's fire breath is losing its power. It was fun while it lasted. Who’s next?

~ Read more from Andrew Moran.