China sovereign debt downgrade: First since 1989

As debt balloons, stock prices fall, currency weakens, default risks increase. Most public govt debt held by Chinese govt domestically, so problem could be solved internally without crisis.

SOVEREIGN DEBT & THE ECONOMY

Moody's downgrades China on debt menace

24/05/2017
Bloomberg News agency

The credit rating agency Moody’s Investors Service has cut its credit rating on China’s sovereign debt for the first time since 1989, 28 years ago.

This downgrade in China's sovereign debt rating challenges the view that the nation’s leadership will be able to rein in debt while maintaining the pace of economic growth.

STOCK PRICES FALL, CURRENCY WEAKENS, DEFAULT RISKS INCREASE

Chinese stocks headed for their lowest level in almost eight months, the yuan retreated in both the onshore and overseas markets, and default risks increased after Moody’s reduced the rating to A1 from Aa3 on Wednesday.

It cited the likelihood of a “material rise” in economy-wide debt and the burden that will place on the state’s finances, while also changing the outlook to stable from negative.

SOVEREIGN DEBT HELD MOSTLY BY DOMESTIC INVESTORS

China’s sovereign debt is mostly held by domestic investors, shielding the nation somewhat from the impact of ratings changes.

Still, the move underscored doubts President Xi Jinping’s government can simultaneously cut excessive leverage in the financial system while keeping economic growth above the target of at least 6.5%.

PSYCHOLOGICAL BLOW TO CHINA

“It is a psychological blow that China will not take kindly to and absolutely speaks to the rising financial pressures in China,” said Christopher Balding, an associate professor at the HSBC School of Business at Peking University in Shenzhen.

That said, “it doesn't matter much in the grand scheme of things because so much of Chinese debt is held by state or quasi- state actors and minimal amounts are international investors”.

RISE IN DEBT FROM TO 260% of GDP FROM 160% IN 2008

Total outstanding credit climbed to about 260% of GDP by the end of 2016.

This is up from 160% in 2008, according to Bloomberg Intelligence.

EXTERNAL DEBT ONLY 12% OF GDP

China’s external debt is low by international standards, at around 12% of gross domestic product (GDP).

This is according to the International Monetary Fund (IMF).

This means that a downgrade isn’t likely to be as disruptive as in nations more reliant on international funding.

Overseas institutions’ holdings of onshore bonds dropped to 830 billion yuan ($121 billion) as of the end of March, from 853 billion yuan three months earlier, People’s Bank of China data show.

That’s less than 1.5% of 63.7 trillion yuan of outstanding notes, according to Bloomberg calculations based on the central bank data.

PREVIOUS RATING WARNINGS & DOWNGRADES

Moody’s last cut China’s sovereign rating was in 1989, when it downgraded the sovereign to Baa2 from Baa1, according to spokesperson, Manvela Yeung.

Moody’s lowered China’s credit rating outlook to negative from stable in March 2016, citing rising debt, falling currency reserves and an uncertainty over authorities ability to carry out reforms.

About a month later S&P Global Ratings also warned that rising local debt was pressuring the nation’s rating.

S&P currently rates China’s foreign and local - currency long-term debt at AA- with a negative outlook, and Fitch places an A+ rating on both foreign and local currency long-term debt with a stable outlook.

Those warnings were followed by the International Monetary Fund (IMF), which in October 2016 said China urgently needs a plan to address a build up of corporate debt that is manageable and that the window to address the problem was "closing quickly."

THE GOOD PART OF THE CREDIT REPORT

Still, Moody’s isn’t hitting the panic button.

"The stable outlook reflects our assessment that, at the A1 rating level, risks are balanced," Moody’s said in the statement Wednesday.

REFORM WILL EVENTUALLY STEM EROSION IN CREDIT PROFILE

"The erosion in China’s credit profile will be gradual and, we expect, eventually contained as reforms deepen."

"The strengths of its credit profile will allow the sovereign to remain resilient to negative shocks, with GDP growth likely to stay strong compared to other sovereigns, still considerable scope for policy to adapt to support the economy, and a largely closed capital account."

SOME COMMENTATORS SAY DOWNGRADE NOT WARRANTED 

Moody’s decision irked some commentators.

"This cut is not solidly grounded," said Wen Bin, chief analyst at Minsheng Securities in Beijing. " China’s economy is in a much better shape than last March when their previous cut happened. Also the policy makers have been well aware of the debt and leverage issues, and actions have been taken. It is a smart move if no one sees the problem and you are the first to flag it. But less so if it has already been noticed and addressed."

The move may still discomfort China investors in that it highlights the risks to the economy rather than the ability of the government to control them.

INTERNAL TRANSFERS & GOVT INTERVENTION WITHIN CHINA WILL SOLVE PROBLEM

“It is not going to come as any great news to the world that China has problems with a huge credit boom that, in the end, is probably going to require government intervention to bear some of the costs," said Richard Jerram, chief economist at Bank of Singapore Ltd.

"In general I think that people are worried about the rapid pace of debt expansion, but re-assured that most is in local currency, so it is more a question of internal transfers, rather than a more abrupt sort of event driven by the capital account."

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