Embattled developer China Evergrande‘s situation is not a surprise, given the steps taken by Beijing to reign in excessive debt in the property sector, according to Orient Capital Research’s Andrew Collier.
“This is all a bit of a tempest in a teapot, which sounds funny given that the whole world is worried about Evergrande right now,” Collier, managing director at the research firm, told CNBC’s “Street Signs Asia” on Thursday.
Collier pointed to Beijing’s “three red lines” policy introduced last year, which was aimed at preventing developers from loading up on debt as well as to deflate the property bubble.
“The end result is one of the largest companies and the most indebted is not surprisingly, in trouble,” he said, referring to Evergrande.
“The fact that they’re continuing … to force developers to try to deleverage is an indication that they think this is a good campaign,” Collier added.
The Chinese authorities’ rationale for such an action is “pretty obvious,” he explained. “They figure that if they don’t do this, then they’re going to have an even bigger crisis on their hands and the entire property market goes into a bubble territory more than it is, and then collapses.”
The ongoing crisis surrounding debt-ridden Chinese developer Evergrande has captured global investor attention for much of this week, and rattled markets.
Hong Kong’s Hang Seng index fell nearly 3% this week, while major indexes on Wall Street also tumbled amid the risk-off sentiment — although they staged a relief rally later in the week.
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If Beijing so desires, it can actually “release the brakes” and ask state proxies such as regional banks to step in and recapitalize Evergrande, Collier said.
Still, he sees authorities as “likely to inflict some pain” on investors to send a clear message that they’re tired of excess in the property sector.
Why global markets are nervous
Collier said there were two reasons why global markets are worried about Evergrande’s troubles.
First, the global financial crisis in 2008 was property-related, he explained. It was sparked by a U.S. housing bubble more than a decade ago. Lehman Brothers, the world’s fourth-largest investment bank at that time, underwrote tens of billions of dollars’ worth of securities backed by risky mortgages during a U.S. housing bubble.
The bank eventually collapsed, having filed the largest corporate bankruptcy in U.S. history. That bankruptcy spilled over to other banks, triggering the global financial crisis.
Still, the current situation in China is different from that 2008 crisis, according to the analyst: “They have direct loans to developers that are problematic, but they don’t have a whole bunch of capital sitting around with a bunch of traders … making up bad securities.”
Furthermore, the Chinese authorities also have “ways of manipulating the banking system.”
That could come in the form of indirect cash injections from the People’s Bank of China to the banks, or through forcing state proxies to step in and aid Evergrande, which the analyst said is “probably what’s going to happen.”
The other area of concern for investors is the importance of China’s property market to its overall economy, as well as the fiscal health of local governments, Collier said.
That means that a crisis in the property sector will translate into problems within the Chinese economy, causing an impact on areas such as global iron ore prices and consumption of goods.