Debt woes at Chinese property developer, Evergrande, sent markets into a spin earlier this week, with investors questioning whether the company would default on $119 million in interest payments due on its bonds. Founded to capitalise on China’s ascending middle class and booming economy, the company is fuelled by $300 billion in debt and is involved in around 800 projects in 234 cities.
Evergrande’s Hong Kong-listed shares have tumbled nearly 90% since July 2020, following a Chinese government crackdown on speculation in the real estate market. The company is facing a growing liquidity crunch and some form of debt restructuring seems likely, though most commentators do not expect a full bailout from the Chinese government.
The general consensus is that even if the fallout is ugly, Evergrande should not be a systemic threat at the same the level as the Lehman Brothers scandal that triggered the Global Financial Crisis. Not only does it seem unlikely that the Chinese government will allow a complete collapse of the company, but only a small portion of its debt is due to offshore companies.
This doesn’t necessarily mean things won’t get messy, however. Guo Shuqing, China’s top central bank official, last year called real estate “the biggest grey rhino” for China’s financial stability – referring to a large yet overlooked threat. The fallout from an Evergrande collapse would include a decrease in appetite for emerging market risk assets – pressuring the rand and the JSE, and a decline in demand for commodities, that could harm the South African mining sector.
The Dynasty Investment Committee has generally avoided listed property as an alternative asset class to equity by favouring short-dated, investment grade corporate credit where we are able to achieve acceptable and stable income yields.
“In the real estate business, you learn more about people, more about community issues, more about life, more about the impact of government, probably than any other profession that I know of.”
– Johnny Isakson, US senator
“There appears to be an acceptance that an Evergrande failure is more a matter of when and not if. The real question is how any fallout is managed.”
– Michael Hewson, chief market analyst at CMC Markets
- The United States is careening toward an urgent financial crisis starting in less than two weeks, as a political standoff on Capitol Hill threatens to shutter the government during a pandemic, delay hurricane aid to millions of Americans, and thrust Washington to the precipice of defaulting on its debt. The high-stakes feud stems from a fight to raise the US government’s borrowing limit, known as the debt ceiling. Mark Zandi, chief economist at Moody’s Analytics, found that a prolonged impasse would cost up to six million jobs, wipe out as much as $15 trillion in household wealth, and send the unemployment rate surging to roughly 9% from around 5%.
- This comes as several global central banks meet this week with news arising from these discussions on policy dominating the week’s investor sentiment and likely to influence market volatility. The US Federal Reserve, Bank of England, and Bank of Japan meetings are scheduled this week.
- Meanwhile in China, financial authorities are ensuring the orderly market exit and well-managed restructuring for troubled companies. Regulators are becoming adept at managing larger, more frequent and highly complex defaults. Although they have had some successes, Evergrande, a massive Chinese property developer on the brink of collapse, is proving to be anything but. Now the world’s most indebted property firm, with $300 billion in liabilities, the company says it has come to an agreement with bondholders on a coupon payment on an onshore bond due this week, easing some fears of an imminent collapse. Analysts had been expecting the company to default on both yuan- and dollar-denominated interest payments. This has caused stock market waves around the world.
- Solving Hong Kong’s shortage of housing and increasing land supply will be priorities for authorities under the new “patriots only” political system imposed by Beijing. Chinese officials have told Hong Kong’s tycoons in private meetings this year that they should pour resources and influence into backing Beijing’s interests and help solve the city’s housing shortage. Shares of Hong Kong’s four major developers, CK Asset, Henderson Land Development, Sun Hung Kai Properties and New World Development, dropped between 9% and 12% on Monday, with analysts citing market worries about potential regulation curbing their growth. The market was more stable on Tuesday.
- The United States will soon allow entry to most foreign air travellers provided they are fully vaccinated against Covid-19; unvaccinated Americans will need a test to travel. The move, which bans the entry of unvaccinated tourists, is the most sweeping change to US travel policies in months. The new rules replace existing bans on foreigners’ travel to the US from certain regions, including Europe.
- In Australia, Melbourne’s construction industry is set to shut down for at least two weeks amid concerns that right-wing extremist groups, who have infiltrated the union movement, are behind violent anti-vaccination protests in Australia’s second-largest city. Angry crowds gathered again on Tuesday, firing flares and fireworks on the streets of Melbourne. Protesters hurled cans and kicked police cars in defiance of the shutdown that will impact much of the state.
- Meanwhile, Australia’s Covid rules are stranding people at state borders in what has been termed “an iron curtain”. State border closures, designed to keep the coronavirus from spreading, have turned retired office workers into roadside nomads. When the pandemic began, many Australians found that the leaders of the country’s six states and two territories, rather than the federal government, suddenly controlled the most vital things in people’s lives, including who could go to work and where they could travel. Read more here.
- According to Federal Reserve chair, Jerome Powell, the US central bank could begin scaling back asset purchases in November and complete the process by the middle of next year. There appears to be a growing inclination to raise interest rates too. Powell says tapering “could come as soon as the next meeting” while the US central bank takes its first steps toward withdrawing emergency pandemic support for the economy.
- South Africa’s JSE was slightly firmer this week with its global peers mixed as markets looked set to recover from Monday’s sell-off, which saw the All Share fall to its weakest level since January. The sell-off was primarily driven by concerns about Evergrande’s liquidity crisis, raising concern about spill over effects for the rest of the market.
- This comes as confidence in the civil construction sector improved marginally in the third quarter of 2021, but more than 80% of respondents to the FNB-Bureau for Economic Research (BER) civil confidence index are dissatisfied with prevailing business conditions. The index, which has been hovering around the 20-point mark since the middle of 2017, rose by four points on a 100-point index to 17 in the third quarter. FNB-BER reported that most underlying indicators worsened in the quarter, which explains the relative pessimism.
- Although BER believes the South African economy could recover to pre-Covid-19 levels by the middle of next year, National Treasury and PwC are of the view that this will only be achieved in 2023. Tax collections at the end of August amounted to just under R590 billion, 9.7% more than the February budget estimate. The sectors underpinning this growth include mining and quarrying, manufacturing, agriculture, forestry and fisheries – and, to a lesser extent, electricity, gas and water, and community, social and personal services.
- The good news is that credit rating agency Fitch has raised its forecast for South Africa’s economic growth and said the country’s budget deficit for the fiscal year will likely be smaller than government’s earlier projections. But this doesn’t mean a positive ratings adjustment is on the cards yet. In a statement on Tuesday, Fitch revised its earlier forecast of 4.9% growth in 2021 up to 5.3%. It further said a “robust economic performance” and stronger-than-expected fiscal revenue in recent months meant SA’s budget deficit in the fiscal year ending in March 2022 would likely be an improvement on projections from February this year.
- A High Court in Pretoria ruling has sent the Independent Communications Authority of South Africa (Icasa) back to the drawing board about the rules governing the allocation of key wireless airwaves. The move will potentially further delay the auction of the radio frequencies as Icasa may be forced to conduct drawn-out public hearings and miss a self-imposed deadline of January 2022 to get the process going. That would be a blow to one of the most important aspects of removing blockages to faster economic growth. Operators and business leaders have long stressed that additional spectrum would expand broadband access and bring down the cost of internet connectivity.
- In more legal news, the Pretoria High Court has ruled that once a mining company is empowered, it is always empowered. It also found that the minister of mineral resources and energy is not empowered to make law, underlining the importance of separation of powers and applying a handbrake to executive overreach. There is an adverse cost finding to boot.
- In company news, Rand Merchant Bank has structured a R8.45 billion syndicated sustainability-linked loan for Mediclinic. The loan offers an incentive-based pricing mechanism that rewards Mediclinic with more favourable borrowing terms provided it meets pre-agreed environment and social performance targets.
- The Competition Tribunal has finally approved Grand Foods Investments and Grand Foods Proprietary’s sale of their shares in Burger King South Africa and Grand Foods Meat Plant to Emerging Capital Partners (ECP) Africa Fund. The sale, approved on 17 September, came with a list of conditions aimed at boosting South Africa’s economy.
- We learned with great sadness that Dynasty’s primary political analyst, Professor Ivor Sarakinsky, passed away last Friday. He was an Associate Professor at the Wits School of Governance and one of South Africa’s leading political commentators. His most recent videos highlight just how deep his understanding of South African politics was. Both Dynasty and our clients will sorely miss his valuable insights that have informed our views about our clients’ portfolio positioning. We extend our heartfelt condolences to his family, friends and colleagues.
Sources: Dynasty, BusinessLive, Bloomberg, Reuters, Washington Post, Moneyweb, Fin24, Gulf News, The Economist, Daily Maverick, etc.