The saga of the debt-laden property developer raises questions about how Beijing is trying to rein in parts of the economy as well as handle slowing growth and the inevitable after-shocks of the pandemic.

Chinese authorities have asked local governments to be prepared for the possible collapse of stricken property developer China Evergrande Group, the Wall Street Journal reported. The story, if borne out, suggests that Beijing doesn’t want to rescue the group.

The officials described actions being ordered as “getting ready for the possible storm,” and said that local-level government agencies and state-owned enterprises have been instructed to step in to handle the aftermath only at the last minute should Evergrande fail to manage its affairs in an orderly fashion, the report said. 

Founded a quarter of a century ago and based in Shenzhen, the fate of the business is a sign of possible cracks in China’s economy. The group reportedly has about 800 projects in progress, so its plight could cause ripples across China.

Evergrande is China's most indebted company, with over $300 billion in liabilities. The company is at risk of default, with an estimated $600 million of interest payments due before the end of the year. Its outstanding bonds have collapsed to one quarter of their face value, while investors in the Hong Kong-listed stock are nursing sizable losses. Its shares have plunged by 85 per cent since the start of the year.

“We doubt this heralds a Lehman-style financial collapse, domestically or internationally. Beijing's recent cash injections into the financial system – through central bank reverse repurchase agreements – and the relatively limited exposure of foreign banks to China, suggests systemic risks are likely containable,” Victor Balfour, strategist at Rothschild & Co, said in a note.

“So far, at least, the wider ripple effects are small: global credit spreads – a measure of corporate stress – are muted, and the recent setback in global stock markets (-3 per cent in September) is unremarkable, especially after such a strong run,” Balfour continued. 

“Evergrande and the property sector have come under such pressure as restrictive policy has sought to constrain what Beijing views as speculative activity in a housing market that is increasingly unaffordable to Chinese workers. Increasing scrutiny of developers, higher mortgage rates, and a government subsidised rental market have all served to cool the property market in recent years, diminishing profits,” he said. 

Balfour said that there are similarities with China's recent attempts to restrain perceived “anti-social activities,” speculative froth and corporate behaviour, such as in the education, gaming and technology sectors. Those crackdowns have rattled international investors. Most famously, hedge fund rainmaker George Soros has warned Western investors that getting into China carries significant risks. 

“The days of property investment leading China's growth may be over. But the risk of a so-called `Minsky moment’ – that Lehman-like event – looks small to us. China's corporate debt is high, but its consumer and (especially) government debt is low. Its still-massive foreign exchange reserves give it substantial "hard currency" assets with which to shore up the banking system should it ever need to do so (which is unlikely, in our view),” Balfour said. 

“As noted, tighter controls on the property sector chime with Beijing's recent policy activism and intervention elsewhere. These developments clearly further complicate the near-term case for Chinese stocks – particularly as economic momentum has faded in recent months. However, we continue to doubt that the longer-term strategic case has been materially damaged,” he added. 

Bernd Hartmann, head of the CIO Office, VP Bank, said: “We assume that the Chinese leadership will intervene, but attention will be paid to the exact form it takes. The authorities will try to prevent a spillover into other sectors by breaking up Evergrande to release liquidity. At the same time, Beijing is likely to try to protect private property buyers who have already paid for their flats and are making mortgage payments but are waiting for completion. The government is thus likely to ensure the completion of real estate projects."

"Based on this scenario, we confirm our tactical positioning. We keep the equity quota at neutral. At the last investment committee meeting, we selectively increased Chinese equities within the thematic allocation targeted at stocks which should benefit from the new political course. Similarly, within the underweight bond allocation, we confirm the underweight of emerging market bonds in favour of an exposure to Chinese government securities and policy banks. High-quality bonds issued by Chinese borrowers have recently benefited from the stock market turbulence,” Hartmann added.