Moody’s downgrade casts doubt on China’s economic narrative
But analysts say Beijing has been taking measures to defuse its debt bomb
Fresh doubts were cast on Beijing’s ability to maintain economic and financial stability at any cost on Wednesday after Moody’s Investors Service downgraded China’s credit rating for the first time since 1989.
The international ratings agency changed China’s long-term local currency and foreign currency issuer ratings to A1 from Aa3, saying the country’s financial strength will be eroded in coming years and debt will continue to rise as economic growth slows.
Hong Kong’s stock market retreated from a 22-month high following the downgrade, while the mainland A-shares market dropped to a seven-month low, closer to the psychological barrier of 3,000 points. Iron ore futures in Shanghai ended down 7 per cent on Wednesday.
China’s Ministry of Finance responded to the move with a statement on its website saying Moody’s used “inappropriate” methods to overestimate the country’s economic difficulties and to underestimate Beijing’s ability to handle such challenges.
“The Moody’s downgrade is based on an inappropriate method … It overestimated the difficulties faced by China and underestimated its ability to deepen structural reform and moderately expand overall demand,” the Ministry of Finance said.
China’s rapid accumulation of debt has become something of an elephant in the room for the world’s second biggest economy.
The country’s overall debt to gross domestic product, an indicator of financial leverage, rose to about 261 per cent by the end of last year – from about 150 per cent in 2008. The ratio for the corporate sector, estimated at 164 per cent, is especially high compared with developed countries, although the direct government debt is only about 40 per cent of GDP.
“The ongoing reforms are not likely to prevent a further material rise in economy-wide debt, and the consequent increase in contingent liabilities for the government,” Moody’s said.
“It’s just confirmation of China’s financial risks,” said Zhang Ming, a senior research fellow with the Chinese Academy of Social Sciences. “The government has realised the seriousness of this problem and has already taken strong regulatory action in recent months.”
The Moody’s downgrade is likely to increase the cost of China’s future debt sales overseas, and it may deter some foreign investors from China’s onshore bond market – despite Beijing’s efforts to entice them.
A lower credit rating may also cast a shadow over Beijing’s ambition of making the yuan a global currency.
Lu Zhengwei, chief economist of the Industrial Bank, said China had been taking measures to defuse its debt bomb.
“It has defined a clear boundary for government debt, improved its transparency and enhanced discipline for local borrowing,” he said. “Corporate debt defaults did increase moderately during the deleveraging process, but this sort of risk relief is a good thing.”
But Moody’s downgrade could be a reality check for Beijing, which has long asserted that the economy is on track and it can overcome any economic challenges – from a property market bubble to a stock market rout.
Premier Li Keqiang in March called for an end to talk of an economic hard landing, while Finance Minister Xiao Jie issued an assurance that the country’s debt risk was controllable.
When Moody’s downgraded China’s outlook to negative at the start of last year, then finance minister Lou Jiwei tried to dismiss it, saying the country “doesn’t care”. This time it was different, and the downgrade drew an almost immediate response from the ministry indicating heightened sensitivity on the issue.
The move has brought to the surface doubts over China’s ongoing handling of financial risk and credit-driven growth.
“The likelihood of a major financial risk outbreak is very low this year but we agree [with Moody’s] that the financial risk continues to rise in the medium- and long-term,” said Zhao Yang, chief China economist of Nomura International in Hong Kong. “Debt risk has not yet been handled substantially and more could be exposed in the coming years.”
Henry Chan Hing Lee, an adjunct researcher with the National University of Singapore’s East Asia Institute, believed the absence of a clear official road map to handle the deleveraging process had triggered the downgrade.
It comes after China agreed to open the door to US rating agencies, allowing them to operate independently rather than as a joint venture, as part of early agreements between Beijing and the Trump administration.