By Oliver Gray
Investing.com - The troubles of China Evergrande Group (HK:3333) have continued to dominate headlines this week after it warned that it could default on its astronomical debt because of a cash crunch, with S&P Global (NYSE:SPGI) speculating on Monday that “Beijing would only be compelled to step in if there is a far-reaching contagion causing multiple major developers to fail and posing systemic risks to the economy.”
The Chinese property sector makes up 25% of gross domestic product, and government officials are attempting clamp down on the excessive debt associated with property speculation. Given that building construction takes about one-third of the steel produced in China from Iron ore mainly supplied by Australia, the correlation between a falling property market and Iron ore price over the past month starts to become clearer.
Six months ago, the Iron ore price was trading at a level of $219.77, since falling 45% to trade around 9 month lows. The decline has reverberated through Australia’s three major iron ore producers, with Rio Tinto Ltd (ASX:RIO), BHP Billiton Ltd (ASX:BHP) and Fortescue Metals Group Ltd (ASX:FMG) losing billions of dollars over the past five days as share prices tumbled.
Inside sources have told financial news service Bloomberg that Evergrande already missed interest payments to two of its largest bank lenders on Monday. The focus is now on whether the company will be able to pay an $83.5 million interest payment for its March 2022 bond due on Thursday. A second $47.5 million interest payment for its March 2024 notes is due on Sep. 29. However, those interest payments are just the tip of the iceberg. The company has a total debt exposure of roughly $US305 billion.
AMP Capital's head of investment strategy, Shane Oliver, noted that "It could set off a contagion through the Chinese credit system, making it harder for other property developers and other borrowers to get funds." Meantime, Oxford Economics lead economist Tommy Wu and head of Asia economics Louis Kuijs said in a note “While we think the government does not want to be seen as engineering a bailout, we expect it to step in to conduct a managed restructuring of the firm’s debt to prevent disorderly debt recovery efforts, reduce systemic risk, and contain economic disruption.”
Earlier in the session, China Evergrande Group’s onshore property unit said it negotiated a plan with bondholders to repay interest due on September 23 on domestic notes, without clarifying the terms of the arrangement.
Indeed, China's ability to contain a financial disaster is about to be tested and, if it fails, an over-excited and leveraged financial system may not be able to cope with the fallout, with Bloomberg reporting that European banks UBS Group AG (SIX:UBSG) and BNP Paribas (PA:BNPP) are directly exposed.
The world's financial system might well be staring at its biggest test since the global financial crisis, even as economies struggle to regain lost ground from the COVID pandemic.