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Will there be a “Great Recession” from China?

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During the week of September 20, global financial markets were temporarily affected by risk-off due to concerns over the default of China Hengda Group (Evergrande).

In particular, on the 20th, fears that the company would not be able to pay interest on its bonds and would default caused global stock prices to fall and prices of non-investment grade (junk) corporate bonds to fall (yields to rise) in the US and elsewhere.

After the 21st, there were more and more observations that the Chinese Communist government would implement some kind of bailout for Evergrande, and that the serious damage to the Chinese economy as a whole would be prevented from spreading.
Therefore, the risk-off did not continue.

On top of that, the fact that Evergrande made an interest payment on its yuan-denominated bonds on the 22nd increased the sense of security among stock investors.

However, it would be premature to assume that the implementation of interest payments = resolution of Evergrande’s debt crisis.

A look at the price of Evergrande’s dollar-denominated bonds shows that the price continues to trend downward.

Ultimately, it is the Communist government’s control that will have the decisive impact on Evergrande’s debt problems.

It is not appropriate to underestimate the risk of bankruptcy.
Immediately after the opening of the Hong Kong market on the 23rd, Evergrande’s stock price rose more than 30% from the previous business day’s closing price.

The reason for this was that on the same day, the company made an interest payment of 232 million yuan (about 3.9 billion yen) on its yuan-denominated bonds.

It is also reported that the Chinese authorities have instructed Evergrande to avoid default on the interest payment on the dollar-denominated bonds, which have a grace period for payment.
At first, the interest payments on yuan-denominated corporate bonds seem to have reduced the alert for default.

For example, in the currency market from around September 15 to September 20, there was an increase in concern that if Evergrande defaulted, it would have a reasonable impact on the Chinese economy.

As a result, the Korean won, which is highly dependent on the Chinese economy, was sold against the dollar.

Later, when it was reported that interest payments on yuan-denominated bonds would be made, the won was bought back.

The implementation of interest payments supported risk-taking by major investors, and global stock prices also rebounded.

Some major investors seemed to interpret Evergrande’s interest payment as a sign of full-fledged support from the Communist government.

Evergrande’s default raises credit risks in China’s real estate sector and other sectors, and carries the risk of causing financial system instability.

With the implementation of the interest payment on March 23, more and more investors believe that the Communist government will not take such a risk in its efforts to eliminate the gap between the rich and the poor.

However, it is too early to be complacent about this latest interest payment.

Evergrande’s debt, including bonds, bank loans, and unpaid bills to clients, exceeds 33 trillion yen.

In the bond market, yields on Evergrande’s dollar-denominated bonds, which will mature between March 2022 and January 2023, have remained high.

It can be said that major bond investors are objectively assessing Evergrande’s debt risk.

The main reason for this is probably the fact that the communist government has not announced a plan to implement a full-scale bailout.
Whether or not Evergrande can avoid a disorderly default and continue its operations depends on whether or not the communist government will implement a bailout.

Theoretically, there is a good chance that a bailout will take place.

And there should be a bailout.

The injection of public funds into companies and financial institutions that have lost the ability to repay their debts is essential to curb the risk that individual credit risks will lead to financial system instability, with serious negative repercussions for the real economy.

Whether or not a bailout is provided will have a major impact on employment in China, and is ultimately a question of the centripetal force of the Communist Party government.
On the other hand, there are reports suggesting that the Communist Party leadership may be reluctant or cautious to provide relief.

Some reports suggest that the leadership has instructed local governments to scrutinize Evergrande’s debt risk and be prepared to take over the company’s business in their jurisdictions if it eventually becomes difficult to repay the debt.

Looked at differently, the Communist Party leadership, which is working to reduce the disparity between the rich and the poor, may be considering bailing out Evergrande as a responsibility of local Communist Party officials.

In China, the risk of default by the local government-affiliated investment company, Loan Pingtai (LGFV), is growing, and there are concerns about the ability of local governments to respond.
It has already been reported that the Guangdong provincial government did not accept Evergrande’s request for a bailout.

It is difficult to determine at this point what the Communist Party leadership, headed by President Xi Jinping, thinks about a full-scale bailout of Evergrande.

The decision-making process of the Communist Party administration is not clear-cut.

In the unlikely event that a full-scale bailout is not implemented, the possibility cannot be ruled out.

For the time being, optimism and pessimism are mixed, and Evergrande’s stock price may remain quite volatile.

From a slightly longer-term perspective, Evergrande’s debt problems may lead to a further tightening of the screws on private companies by the communist government.

 

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