China channels Bernanke with assurances that Evergrande is contained

Hong Kong

FOR months in the run-up to the 2008 financial crisis, banking heavyweights from Federal Reserve chair Ben Bernanke on down said the turmoil in sub-prime mortgages would be "contained".

That phrase is now making a comeback in Beijing as regulators try to reassure markets that the world's second-largest economy can weather the crisis at China Evergrande Group. Investors are hoping Chinese policymakers prove more adept at ringfencing the damage than their Wall Street counterparts were.

People's Bank of China Governor Yi Gang said at a virtual meeting of the Group of 30 on Sunday (Oct 17) that authorities "can contain the Evergrande risk" even as the embattled developer "casts a little bit of concern". Another PBOC official called the situation "controllable" at a news briefing on Oct 15, echoing statements from several of the country's largest lenders in recent weeks.

For now, financial markets show few signs that Evergrande's troubles will spiral into a 2008-like crisis. Credit stress hasn't spread much further than Chinese developers, while a stable yuan suggests capital outflows are not a concern. Central bankers in South Korea, Malaysia and Europe are sanguine about the risks, while much of Wall Street dismissed comparisons to Lehman Brothers. China's sovereign credit default swaps have slumped in the past week. One refrain among optimists: China's government helped engineer the stress at Evergrande by tightening curbs on the real estate industry, and can therefore limit the pain if needed.

"I don't think China's frankly that dumb," Bill Winters, chief executive officer of Standard Chartered, told Bloomberg Television last week, when asked if Evergrande would cause a global crisis.

Still, signs of a spillover into the economy are hard to ignore. Data on Monday show that Chinese home sales by value tumbled about 17 per cent in September from a year earlier, while economic growth slowed more than expected.

The country's US$12 trillion onshore bond market has also started to crack.

Here's a sampling of metrics to show whether Evergrande's plight is being contained:

Credit stress

Stress is evident in China's real estate sector, which accounts for almost half of the world's distressed dollar-denominated debt. Yields on Chinese junk dollar bond market - dominated by property developers - recently surged past 20 per cent to the highest in a decade. China high-yield credit spreads over comparable Treasuries are near the widest on record - at about 2,055 basis points on an option-adjusted basis. Investment-grade bonds appear "oversold", according to Citigroup.

The turmoil has also led to a slump in bond sales. Chinese borrowers have priced only US$1.7 billion of offshore dollar notes in October, the least for the period since 2015. Sales in Asia have dropped to US$3.5 billion, on track for the slowest month this year.

Financial plumbing

Elevated dollar-yuan swaps suggest some Chinese banks may be hoarding yuan to hedge against a liquidity squeeze. But the People's Bank of China is draining funds from the financial system almost daily in October, a sign that lenders have adequate cash. Short-term borrowing costs remain low at around 2.1 per cent in the repo market - which, like in the US, is the primary source of funds for the securitised banking system. In other words, China's interbank lending market is fine.

China's currency has been resilient through the Evergrande crisis. The yuan has strengthened almost 0.5 per cent against the US dollar in the past month. There is little evidence of central bank intervention, with the country's foreign exchange reserves remaining largely stable.

The domestic stock market too is showing signs of calm. While the CSI 300 Index is down 16 per cent from its February peak, much of the decline was caused by official efforts earlier in the year to reduce pandemic stimulus-induced froth. In the past four weeks the gauge is little changed. A gauge of Chinese real estate companies is trading near a three-year low.

Economy

The slowdown in the property market is having an impact on the economy, given that the real estate industry accounts for almost 30 per cent of gross domestic output and 40 per cent of household assets. The economy expanded 4.9 per cent in the third quarter, down from 7.9 per cent in the previous quarter, according to official data on Oct 18. An energy crisis also weighed on growth.

Beijing's property crackdown has curbed construction activity and squeezed financing to the sector. Combined contracted sales by the country's top 100 real estate companies plummeted 36 per cent in September from a year earlier.

Beyond China

Indexes of speculative-grade debt in the emerging world and in the US are showing relative calm, with yields at around 7.2 per cent and 6.5 per cent, respectively.

MSCI's benchmark of global shares is just 2.2 per cent away from an all-time high. The third-quarter earnings season showed business is booming among Wall Street investment banks. The VIX - often called the "fear gauge" - is about 18 per cent lower than its average for the year. BLOOMBERG