Chinese real estate contagion scares the markets

Global stock markets hit a massive sell-off yesterday, triggered by concerns about the condition of the Chinese economy. These were connected a few weeks back with the spread of the delta variant of coronavirus, but now the attention of markets is focused on the problems of real estate giant Evergrande. The second largest Chinese developer has reached the brink of bankruptcy, the negative effects of which could hit hard not only the domestic real estate sector, but also indirectly the related parts of the Chinese economy and financial markets.

The real estate sector has been one of the main drivers of China's economic growth since the beginning of the new millennium, but there has been a marked cooling in recent months. The situation is most serious in the case of the developer Evergrande, which reported problems with the repayment of liabilities in excess of $ 300 billion (approximately 2% of Chinese GDP). Evergrande shares have depreciated 84% since the beginning of the year, and other Chinese development companies are also under significant pressure - for example, shares of developer Sinic fell by a huge 87% (!) On the Hong Kong Stock Exchange yesterday.

The Chinese real estate sector came under pressure both in connection with the economic slowdown following the outbreak of the coronavirus pandemic and as a result of the stricter regulatory policy of the Chinese government (the so-called three red line policy). It responds to the over-indebtedness of the domestic real estate sector, or rather the fear that it could be the source of a systemic crisis that would threaten the stability of the Chinese financial sector. Another reason for stricter regulation is the effort to suppress the unproductive allocation of capital, ie to shift resources from the real estate sector to more agile parts of the Chinese economy, for example, focused on the transition to carbon neutrality.

Given that stricter regulation of the real estate sector is in itself a response to the vulnerability of the Chinese economy, no significant exchange rate turn can be expected from the regulator. On the other hand, although the Evergrande bailout now seems unlikely, the Chinese government will want to eliminate the risk of the disease spreading from its eventual insolvency. In other words, China is definitely not interested in its own "Lehman Brothers moment". However, until there is a clear signal from the regulator on how to deal with Evergrand's liabilities, financial markets may remain under pressure.

Author: Jan Bureš & Petr Dufek , Patria Finance and ČSOB Finanční trhy