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There’s another big risk brewing in China

There are a number of reasons for global investors to be keeping close watch on China, from signs its economy is slowing to Beijing’s disruptive crackdown on private business. But the list doesn’t end there.

What’s happening: Evergrande, one of China’s largest property developers, is in dire straits. It warned this week that it could default on its substantial debts, listing $300 billion in total liabilities, if it can’t raise money quickly. Should that happen, the effects would be felt across the country’s banking system. The group has also suspended work on some projects as it tries to conserve cash, a move that’s poised to hit China’s property sector. Investors are clearly worried. Evergrande’s shares in Hong Kong are off 72% this year. That’s significantly worse than the 29% plunge suffered by Alibaba (BABA), which has been at the center of the Chinese government’s efforts to rein in big tech firms. Hong Kong’s Hang Seng index is off 4% year-to-date.

Evergrande’s bonds are also under pressure, as is its electric vehicle business, which Bloomberg recently identified as the worst performing stock in the world. Step back: Debt in China’s property sector has been a lingering risk to the country’s financial system for some time. And Evergrande is one of China’s most heavily indebted developers. It has $37 billion in borrowing due within one year. Should Evergrande actually default, it would be another destabilizing jolt at an already tenuous moment for markets and the economy.

Though not guaranteed, Beijing would likely intervene to soften the blow, Julian Evans-Pritchard, senior China economist at Capital Economics, said in a note to clients in July. “China’s leadership is presumably reluctant to offer a bailout to Evergrande, given the desire to punish reckless behavior by private entrepreneurs and discourage speculative property investment,” he wrote. “But given the firm’s sheer size and systemic role, officials would step in to try to ensure an orderly restructuring in the event of a default.” That said: A default would likely lead to tighter financing conditions for the entire real estate sector, hurting their businesses.

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