IMF confident China can handle Evergrande crisis

SHANGHAI, 13 Oct 2021:

Chinese authorities “have the tools to step in” if the crisis triggered by the mammoth indebtedness of real estate giant Evergrande worsens, the International Monetary Fund (IMF) has said in a report, warning of “a risk that broader financial stress may emerge.”

The October update of the Global Financial Stability Report, published yesterday, pointed out the coronavirus pandemic impact so far has been limited to financially weak property developers and lower-rated firms.

“I think the Chinese authorities have fiscal power and space, as well as legal and institutional means, to tackle the problem,” Tobias Adrian, director of the IMF Capital and Monetary Markets Department, said in a virtual press conference.

Apart from Evergrande, facing a possible default of some of its offshore bonds with more than US$300 billion in liabilities, some smaller promoters like Sinic, Xinyuan, and Fantasia have revealed liquidity problems to meet their obligations.

The report underlined the “challenging trade-offs” in the extent of support to affected financial entities and sectors and the timing of the intervention.

“The broader the support measures, especially if accompanied by an actual or perceived relaxation of the broader effort to de-lever the financial system over time, the greater the risk of financial fragilities re-emerging in the future,” said the report.

It said a well communicated and prompt intervention would likely minimise the risk of contagion but at the cost of reinforcing a perception of individual firms being too big to fail.

“Postponing support to the financial system to instil market discipline may, however, require broader measures to manage financial stress.”

The IMF recommended that China must tighten insolvency frameworks to facilitate the market-based exit of non-viable firms for long-term effects.

“In the short term, the tools are available to contain and manage potential financial stress and lessen any adverse impact on the economy.”

Despite its confidence in Chinese capabilities, the IMF warned of the possibility of broader financial problems emerging, with implications for the domestic economy and, in an extreme case, for global capital markets.

For potential domestic financial effects, the IMF warned that even as aggregate direct exposures of Chinese banks to Evergrande appeared to be limited, smaller banking institutions with weaker capital positions might face challenges.

“However, should stress spread widely to the broader property development sector, the exposures of the financial system would be meaningfully larger.”

It said several financial institutions – including banks, trust companies, and other shadow banking entities – were involved directly through loans, bonds, and other credit instruments, as well as indirectly via guarantees and contingent liabilities.

The debt had accumulated “often through opaque and difficult-to-quantify channels that create a high degree of interconnectedness within the financial system,” said the report.

The IMF warned that offshore markets could come under stress and create funding challenges for other issuers because property developers accounted for a significant share of borrowing.

It said knock-on effects on real estate firms could adversely impact growth given sizeable liabilities to various counterparts.

A sustained fall in house prices could weigh on consumer confidence and spending.

The IMF said it would prompt a fall in government land sale revenues, forcing local governments to reduce public investment and reinforcing investor concerns about state support for local government-owned entities, especially in provinces with weak public finances.

The world body noted that a slowdown in economic growth and a tightening in financial conditions in China could bring spillovers to the rest of the world, through direct exposures of international investors to Chinese financial assets.