The US Federal Reserve warned in its semi-annual financial health check overnight that stress in China's real estate sector could pose "some risks" to the American financial system, pointing to the recent concerns surrounding China Evergrande Group, the world's most indebted property developer.

In its latest Financial Stability Report, the US central bank said the ongoing regulatory scrutiny by Beijing over corporate debt levels has the potential to stress the property sector and other highly indebted businesses, which could lead to spillovers to financial firms, a sudden correction in real estate prices or a reduction in investor appetite in the mainland.

"Given the size of China's economy and financial system as well as its extensive trade linkages with the rest of the world, financial stresses in China could strain global financial markets through a deterioration of risk sentiment, pose risks to global economic growth, and affect the United States," the Fed said.

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The statement came about two months after Fed chairman Jerome Powell downplayed the potential risk of contagion from Evergrande at a press conference, saying the Evergrande situation "seems very particular to China".

Evergrande, China's biggest builder of homes, has struggled under the weight of 1.97 trillion yuan (US$308 billion) in total liabilities and missed several interest payments on its offshore debt in recent months, fuelling concerns about high debt levels in the property sector.

The Shenzhen developer has managed to avoid defaulting on its debt by repaying some missed payments within a 30-day grace period, delivering a smaller amount of homes and repaying suppliers.

However, other developers, such as Fantasia Holdings Group and Sinic Holdings Group, have defaulted on their debts in recent weeks, increasing investor uneasiness about a potential contagion.

Even as concerns are growing, some investors are buying into Chinese property sector debt as it has sold off sharply in recent months.

Unfinished flats at the construction site of Evergrande's Health Valley development on the outskirts of Nanjing, China. Photo: Bloomberg alt=Unfinished flats at the construction site of Evergrande's Health Valley development on the outskirts of Nanjing, China. Photo: Bloomberg

Goldman Sachs Asset Management, for example, has added a "modest amount of risk" through high-yield offshore bonds issued by Chinese property developers, with a portfolio manager saying the market has overestimated the contagion risk.

China regulatory and property risks were cited as one of the top three risks to US financial stability over the next 12 to 18 months by market professionals surveyed by the Fed staff, outpaced only by persistent inflation and vaccine-resistant variants of Covid-19. The Fed conducted its survey of 26 market contacts between August and mid-October.

Market participants also cited concerns about the potential escalation of US-China tensions as another risk that could destabilise markets, particularly surrounding Taiwan.

The Fed separately warned that adverse developments in other emerging markets economies spurred by a sharp tightening in interest rates could also spill over to the US.

"A sharp tightening of financial conditions, possibly triggered by a rise in bond yields in advanced economies or a deterioration in global risk sentiment, could push up debt servicing costs for EME [emerging market economy] sovereigns and businesses, trigger capital outflows, and stress EMEs' financial systems," the central bank said.

"Widespread and persistent EME stresses could, in turn, have repercussions for the US financial system through its direct exposures to stressed EME businesses and sovereigns and through its indirect exposures via US businesses with strong links to EMEs."

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2021 South China Morning Post Publishers Ltd. All rights reserved.

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