Evergrande: fighting moral hazard versus systemic risks + Dutch Budget

China Macro: Evergrande distress adds to systemic risk fears

Problems at China’s large real estate developer Evergrande has impacted sentiment on global financial markets in recent days. Evergrande was downgraded by the leading rating agencies to very low levels, indicating a high likelihood that the company will fail to honor USD 120 mn in debt service obligations due coming Thursday. Due to the sheer size of the company, its strong linkages with Chinese banks and non-bank financial institutions and the importance of the real estate sector for the Chinese economy, fears of potential systemic risks stemming from an Evergrande failure have risen. This has triggered market corrections beyond China.

Although the problems at Evergrande (such as liquidity management) are partly company-specific, there are broader real estate sector issues at play. With ‘Housing is for living in, not speculation’ being a key slogan, Beijing is keen to end malpractice in the sector. The government has already been tightening regulation for (the financing of) property developers for a year or so – a policy referred to as the three red lines‘, aimed at deleveraging and improving financial health of the sector. This policy, part of a broader campaign to reduce financial risks, had already quite some impact on the real estate market, with for instance property sales cooling significantly. This has aggravated the financing issues for a company like Evergrande.

Policy makers balancing between reducing moral hazard and safeguarding financial stability

While the problems at Evergrande will not be solved overnight, and this could cause further reverberations in global markets and add to downside growth risks, we assume that Chinese policy makers will seek a balance between reducing moral hazard and safeguarding financial stability. Over the past years, preventing systemic risks has been an important anchor for Beijing in managing all kinds of risk events, so it would not seem very logical to steer this case purely from the perspective of ‘reducing moral hazard’. Although curtailing a big company with malpractice does seem to fit with Beijing’s regulatory crackdown and its shift to common prosperity, but punishing ‘the Chinese middle class’ (including home-owners, small investors, employees and suppliers) does not. All in all, it looks likely that we will see some form of a ‘mixed solution’, with debt restructuring (to deal with the moral hazard issue) on the one hand, and some form of intervention to limit systemic risks on the other. Beijing has the tools to interact and engineer a longer-term solution, both in financial terms but also in governance terms. A similar mixed solution was found for the asset management company Huarong earlier this year, although that was a state-owned company while Evergrande is a private firm. On the macro policy front, we expect further piecemeal monetary and fiscal easing, while having downgraded our 2021 growth forecast, see our recent China update here. (Arjen van Dijkhuizen)

Dutch Budget 2022: A smaller deficit due to the phasing out of Covid support

The Dutch government presented its budget for 2022 today, on ‘Prinsjesdag’. Due to the caretaker status of the current government it is customary to have a policy-light budget. However, it is clear that the first time since the start of the pandemic the budget will be less dominated by Covid-related expenditure. The deficit for 2021 is expected to come out around -5.4% of GDP according to the latest estimates by the CPB (the Netherlands Bureau for Economic Policy Analysis), while the deficit for 2022 is estimated at around -2.3% of GDP. The main driver for the 2022 budget balance improvements is the phasing out of generic government support.

Impact pandemic on Dutch economy relatively moderate compared to eurozone peers

The global pandemic has had a dramatic impact on economic activity and government finances of all eurozone member states. Still, there are wide differences between the various countries. Overall, it turns out that the Dutch economy was amongst the ones that were hit the least hard during the pandemic. Moreover, the damage to government finances in the Netherlands will likely be more moderate than in most other big eurozone countries. Indeed, according to current estimates the Netherlands will be the only large eurozone country (with a share in eurozone GDP larger than 1%) where the government debt ratio has remained below the 60%-limit in 2021.

Dutch State’s borrowing requirement is expected to decrease in 2022

We estimate next year’s borrowing requirement at around EUR 98bn, which compares to a borrowing requirement of EUR 115bn for 2021. Despite a significant decline in the budget balance, the total borrowing requirement remains relatively elevated, which is largely due to a high amount of maturing bonds in 2022 as well as a high amount of maturing short-dated paper. This is because the Dutch State has expanded the money market to absorb shocks to its financing need induced by the pandemic. In contrast, we expect the receipts from deferred taxes and from the EU Recovery Fund to lower the total borrowing requirement. (Floortje Merten, Jan-Paul van de Kerke & Aline Schuiling)