Ratings war

Squaring up to the dollar

In the first century AD, a historian called Ban Gu wrote an account of the Han Dynasty, which introduced one of the most famous concepts in Chinese history: shishi qiushi. It means seeking truth from facts. Various Chinese leaders have adopted his adage since then including Deng Xiaoping, who wanted policy decisions to be determined by empirical truths rather than dogma.

But here’s the rub: facts are subject to interpretation.

Take one example: in 2013 the US ran a $680 billion fiscal deficit, amounting to 4.1% of GDP. China’s analysis of this fact leads it to believe America should be paying a lot more than it currently does for the debt it needs to service this deficit. Few things grate with Chinese treasury officials more than the funding benefits afforded by the dollar’s status as the world’s reserve currency. In his book, Exorbitant Privilege, the US economist Barry Eichengreen quantifies it as a 2% to 3% gap between the cost of US foreign liabilities and the return it makes on its foreign investments.

China vehemently believes the three international rating agencies – Standard & Poor’s, Fitch and Moody’s – actively maintain the status quo by assigning favourable ratings to Western countries. As domestic rating agency Dagong puts it, “The developed countries have been taking advantage of their higher credit ratings to control 90% of global credit resources, maintaining their economic privileges.”

Dagong has been working hard to overturn this perceived bias, pointedly rating America’s credit worthness on a par with Botswana. It has long argued that sovereign ratings should be determined by a country’s ability to generate wealth rather than the criteria it accuses the big three of using: their political system, central bank independence and GDP per capita.

This is a story of one David fighting three Goliaths. Even in its home market, Dagong still only has a 30% market share. In a bid to increase its clout, the agency has entered into a joint venture with Russian credit rating agency RusRating.

During a visit to China last week, Russian Finance Minister Anton Siluanov said the new entity will begin by appraising Sino-Chinese investment projects, but will eventually be far broader in scope. The news comes on the back of a recent flurry of tie-ups between the two countries, most prominently the signing of a $400 billion, 30-year gas supply contract (see WiC239).

Russia’s geopolitical desire to embrace China has also been fuelled by a recent ratings decision. In April S&P downgraded Russian debt to just one notch above junk status following Moscow’s annexation of Crimea. Yet critics say the new Sino-Russian rating agency will fail to gain any sway if it is about anti-Western politics rather than cold, hard business decisions.

The Hong Kong Economic Journal further argues that Dagong is subject to the same conflicts of interest as the big three, and has never objectively rated Chinese entities. Dagong acknowledges as much. In March, its chairman Guan Jianzhong told Bloomberg that “cut-throat competition” was hurting the local ratings industry, making it less about accurately evaluating risk than offering the best pricing and rating.

When the new joint venture – Universal Credit Rating Group – was first announced in 2012, a third partner was Egan-Jones, a minnow American rater. Siluanov did not mention whether Egan-Jones is still involved, but many commentators believe the US firm’s model of charging investors rather than issuers for ratings points the way forward for the industry as a whole.

Universal Credit Rating symbolises another step towards a multi-polar world, say China analysts. They point to a recent report by the University of Heidelberg that rating agencies not only have an innate leaning towards their home sovereign, but other countries which speak the same language as well.

The new group looks likely to exploit any opportunity opened by Moscow’s tensions with the West. Its client list will likely grow as more Russian companies try to source finance from Chinese investors and financial institutions, substituting these for less readily available Western sources of funds.

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