Exposure rates of the Dorval Asset Management Range – 17th September 2021

The weeks ahead will reveal how China will actually manage the Evergrande affair and hence provide some insight into the financial fallout. There will be a real economic impact for China, although this is set to be at least partly offset by the positive effects of greater control over the Delta variant.

With debt standing at more than $300bn, the leading Chinese real estate developer is in the midst of default. Experts expect an orderly restructuring for the majority of its debt, although the affair is clearly in the hands of the Chinese authorities, which obviously leaves some margin for uncertainty – be it good or bad. This financial event is already broadly priced in, with Evergrande’s short-term debt now carrying a 75% discount (cf. chart 1).


Downfall of Chinese real estate heavyweight, Evergrande
Evergrande’s 6.98% July 2022 bond price


This affair is the source of much wringing of hands, but does not come as a total surprise as since 2017, China has rolled out macroprudential policy measures aimed at diminishing leverage and risk-taking in the financial system, where real estate accounts for a hefty portion. A number of smaller businesses have already defaulted due to successive rounds of tightening the regulatory thumbscrews. However, Evergrande’s vast size means that credit spreads in the Chinese high yield universe – where real estate developers account for 60% – have expanded across the board. The Chinese central bank has therefore started injecting liquidity into the system to avoid it seizing up altogether. Even if the Evergrande issue is managed without triggering a major crisis, a slowdown in the real estate sector is now already on the cards (cf. chart 2).



Evergrande affair should lead to real estate sector slowdown in China

Business climate in Chinese real estate sector (NBS) (RHS) / High yield bond prices in China (LHS)


However this slowdown will be partly offset by a stronger grip on the Delta variant now that the vaccination campaign has picked up the pace. The situation is not yet fully under control – as demonstrated by the upsurge in cases in Fujian province – but it seems to be sufficiently in hand to expect an increase or a stabilization in the services sector by the end of the year, after a sharp slowdown over the summer (cf. chart 3). This boost will also have a knock-on effect in the rest of Asia where Covid cases have plummeted over recent weeks, so unless the Chinese authorities handle the Evergrande affair very poorly – triggering an overall tightening in financial conditions in Asia – the country’s real estate difficulties should have an only moderate economic impact on the rest of the region.



Grip on Delta variant should buoy growth in China and the rest of Asia

Services PMI in China / Weekly Covid-19 cases


Additionally the structural slowdown in China pursued by the authorities, as well as the Evergrande affair’s short-term impact for the real estate sector, should curb rising prices for industrial commodities worldwide. Overall, the Evergrande affair does not jeopardize our scenario for an overall upturn in the world economy in the short term, driven by a grip on the Delta variant worldwide – again assuming that the issue is managed in such a way as to ward off a financial crisis. News has been encouraging in both Europe and Japan, where Covid cases have fallen, and more recently in the US, where cases are hitting a peak. Meanwhile the latest US figures also show an upturn in the manufacturing sector business climate in September, along with a dip in inflation. Bottlenecks and factors that have been pushing up certain prices will not be brought under control for several months yet, but the overall trend is now looking more upbeat. We have made no changes to our allocation, but we are obviously closely monitoring the situation in China.




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