The property developers have more than $US200 billion ($271 billion) of US dollar-denominated bonds outstanding in an offshore bond market essentially closed to new property-related issuance.
Those with cash are being directed by the authorities to prioritise honouring their pre-sales commitments by completing developments over meeting debt obligations. Their woes and falling property prices have cut off the supply of another source of cash and liquidity from new pre-sales.

While the most stressed developers,like Evergrande,have been able to stave off formal defaults thus far,with Evergrande scraping up some cash to make late interest payments,new payment obligations keep surfacing.

Evergrande,for instance,has payments on three dollar bond issues due this week after using up its 30-day grace periods. If it were to miss those payments it could trigger cross-default provisions within the more than $US19 billion of dollar bonds it has issued.

The size and importance of the property sector within China,its indebtedness – apart from the bond issues and shadow banking debt,Bloomberg has estimated Chinese banks are exposed to developers to the tune of about $US8 trillion,or nearly 30 per cent of their total lending – and the extent to which property values had been inflated means it is an obvious threat to the stability of China’s financial system and economic growth.

The developers are being cut off from dollar bond funding,from pre-sales funding,from the cash raised through shadow banking channels and are being forced to devote what cash they have to completing projects for which they’ve already been paid.

Add the tighter controls on borrowing and lending against property that have been imposed by the authorities and the ingredients for something quite unpleasant are in place.

The authorities in China loathe any sort of economic or financial instability,seeing it as a threat to political stability. They may yet act to ensure the risks to China’s growth and stability – and the growth and stability of other economies – emanating from their property sector are contained and defused.

The authorities have expressed confidence that the risk of the sector’s problems developing into a wider threat to the financial system are controllable but don’t seem to be doing anything of substance to control them,focusing more on protecting home buyers and suppliers than on insulating the wider system against risk.

The Fed is now saying that the domestic stresses could be transmitted outside China and be of sufficient magnitude to pose risks to systemic stability and growth elsewhere.

By itself it is unlikely that a domestic property market meltdown would have systemic implications in developed economies elsewhere,although a consequent slowdown in China’s overall growth rate would have flow-on effects,particularly within Asia.

Foreign investor losses on Chinese bonds and shares would be significant but not enough by themselves to shake the US or other major financial systems.

If a property market meltdown were to coincide with a general tightening of global financial conditions,however,the Fed’s concerns about China and emerging market economies might be realised.

Globally,conditions are tightening. Central banks are either starting to wind down the monetary policy stimulus they provided in response to the pandemic or are close to doing so. Interest rates globally are on the rise. The unprecedented levels of fiscal stimulus the pandemic induced are being withdrawn.

Financial markets are sensitive to the shifts occurring and to the potential,caused by levels of inflation not experienced for decades,for the safety nets of ultra-low interest rates and abundant liquidity provided by central banks since the 2008 financial crisis to be yanked from underneath them.

The Fed report noted that a sharp rise in interest rates could lead to a large correction in the prices of risky assets and stresses within financial institutions,businesses and households.

It wouldn’t take much in these circumstances for a spark in China to cause a global firesale of inflated assets.

The authorities in China loathe any sort of economic or financial instability,seeing it as a threat to political stability. They may yet act to ensure the risks to China’s growth and stability – and the growth and stability of other economies – emanating from their property sector are contained and defused.

It remains unlikely that China’s property sector woes could create a “Lehman moment” by themselves but the fragility and vulnerability of global financial settings as the world tries to migrate out of pandemic-inspired monetary and fiscal policies even as inflation rates remain elevated means that possibility can’t be completely dismissed.

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