Concerns over a potential fallout of the inability of China's Evergrande Group - a real estate conglomerate - to service its debt is sending shockwaves across global markets, with metal companies especially bearing the brunt.
Investors fear that Evergrande, once China's largest property developer but now the world's most indebted developer with nearly $305 billion in debt, could cause a financial tsunami in case of its collapse, both locally and globally. The ripples from such a collapse may look similar to the collapse of the Lehman Brothers in the US in 2008, that began the global financial crisis.
A research note put out by London-based firm Capital Economics calls the potential collapse of Evergrande one of the biggest tests that China's financial system could face in years. The note also says that the immediate reason behind Evergrande's situation is the Chinese governmental policy of the 'Three Red Lines', forcing Evergrande to offer steep discounts to maintain cash flows.
The prices of copper and iron ore continue to thread downward worldwide, having implications on metal stocks around the world, as markets prepare themselves for reduced demand in China should a collapse of Evergrande have larger implications on its financial system. Iron ore futures were priced at less than $100 a ton in Singapore on September 20, down 60% since May, tumbling 11.5%, with local Chinese restrictions on industrial activity complemented with a muted demand from Chinese real estate.
On the Chicago Mercantile Exchange in the United States, the contract for iron-ore fell 8.3%, nearly down 37% this month, to $91.75 per metric ton.
A slowdown in China risks the US going into a recession next year. "China is the largest importer of oil and iron ore in the world, so any slowdown of growth in China will reduce demand for those commodities", Jay Hatfield, chief executive officer and founder of Infrastructure Capital Advisors in New York, told MarketWatch.
The firm is scheduled to make a payment of $83.5 million worth of interest on bonds that expire in March next year on Thursday, and for another $47.5 million on September 29 on notes that expire in March 2024, which is expected to serve as a test of its financial strength. A report by S&P Global, reported by CNBC, has said that a "default is likely" on these payments.
"The financial fallout would be far reaching. Evergrande reportedly owes money to around 171 domestic banks and 121 other financial firms," the Economist Intelligence Unit's (EIU) Mattie Bekink told the BBC. The story says that if Evergrande defaults, banks and other lenders may be forced to lend less, leading to what is known as a credit crunch, when companies struggle to borrow money at affordable rates.
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Markets are also looking at steps that the Chinese government could take to diffuse the situation. However, several rating agencies and research houses advice against hoping for a great degree of intervention.
"We do not expect the government to provide any direct support to Evergrande," said a report by S&P Global. "We believe 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."
Indian equities too bore the brunt of the selloff. Metals were a drag on Monday, September 20, with the National Stock Exchange's Nifty Metal index falling more than 4% or 250 points. However, the index recovered in trade today, gaining 2.55% or 135.45 points, ending at 5444.45.
The NSE's benchmark index Nifty 50 closed 0.95%, or 165.10 points higher, at 17,562 points.