“Unbelievable” said China Daily of Moody’s decision on China’s sovereign debt rating. Late last month the rating agency downgraded China one notch from Aa3 to A1. But the newspaper’s one-word response actually harks back to July 1988, when Moody’s first assigned the country an A3 rating.
Much has changed in the 30 years since China’s Ministry of Finance launched the first international bond deal in its own name, not least the currency in which it was denominated: the Deutschmark. What isn’t new is the sensitivity to perceived slights or the suspicions of bias by the American rating firms.
Back in 1988 the government complained it deserved at least double-A status, which was three to four notches higher on Moody’s scale. Also galling was that India and South Korea had higher A2 ratings (since then China has surpassed India, which has dropped to Baa3, but not South Korea which is now Aa2).
This time round, Ministry of Commerce official Mei Xinyu blasted the ratings agency in a People’s Daily op-ed. “It’s clear the logic behind Moody’s assessment goes against the objective facts,” he scoffed. At issue is the agency’s belief that “financial strength will erode somewhat” if Chinese debt continues to increase as GDP growth slows to around 5% in five years time. The agency acknowledged that government-led reforms have transformed parts of the economy and financial sector, but said they are “not likely to prevent a material rise in debt and contingent liabilities for the government”.
The Chinese haven’t accused Moody’s directly of political bias as they did in 1989 when it last downgraded sovereign debt from A3 to Baa1 following student protests in Beijing. Back then a Bank of China official said it was “wrong to apply Western formulas to China and consider political factors more than economic ones”. At that point, only Moody’s rated China. Standard & Poor’s then awarded a debut BBB rating in 1992, followed by an A- from Fitch in 1997, and from the early 1990s until 2013 China’s rating trajectory was almost always in a positive direction.
That changed when Fitch issued a downgrade in April 2013 citing credit growth following the country’s massive stimulus programme after the global financial crisis. Fitch will have done little to improve the mood in Beijing by raising Taiwan’s credit rating above China’s last October. After Moody’s own move late last month the island now enjoys a higher rating from two of the three agencies. S&P has China’s AA- rating on negative outlook, whereas Taiwan’s AA- rating is on stable outlook, and market participants believe that S&P will move more in line with Moody’s and Fitch by downgrading China next year.
Last month’s downgrade has largely been shrugged off by the financial markets, which had widely expected it. Bond prices dipped a couple of basis points before recovering, helped by technical support from lower-than-expected supply from China so far this year. Spreads have also been bolstered by the fact that the main buyers of Chinese bonds offshore are the Chinese themselves. In fact, the domestic focus of the country’s debt capital markets and China’s restricted capital account are the main reasons why many believe the deteriorating debt-to-GDP ratios are less worrisome than they first appear.
When China launched its first sovereign bond the Bank of International Settlements (BIS) did not even have information on the country’s debt levels. Record-keeping began in 1995 when China had total debt of Rmb6.6 trillion or 108.7% of GDP. The most recent BIS data posits a figure of Rmb27.8 trillion in September last year, or 255.6% of GDP.
Last year the IMF issued warnings that the economy’s dependence on credit was “increasing at a dangerous pace” and urged Beijing to stop its state enterprises and local governments from ploughing more money into unproductive investments. Another concern was China’s shadow banking system, which has become much larger and more complex. The swing factor, the IMF noted, was reform, something that all three rating agencies have urged Beijing to accelerate. The IMF estimated that further deleveraging would result in a central government debt-to-GDP ratio of 50%, better than many Western countries. Failure to make changes would push the ratio closer to 70%, higher than the OECD average, and a possible prompt for further downgrades.
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