S&P’s China downgrade may deter forex liberalisation plans

Market turbulence arising from the S&P downgrade could see Beijing hold off relaxing controls in foreign exchange ahead of the 19th Party Congress

PUBLISHED : Sunday, 24 September, 2017, 6:14pm
UPDATED : Sunday, 24 September, 2017, 11:56pm

The decision by prominent US financial agency S&P Global Ratings to downgrade China’s sovereign rating is likely to deter some financial liberalisation plans under consideration in Beijing, particularly as the decision was made at a sensitive time, analysts said.

On Thursday, S&P downgraded China’s sovereign credit rating from AA-minus to A-plus – the first time it had adjusted the rating since 1999 – saying the move reflected increased economic and financial risks in China after “a prolonged period of strong credit growth”.

“The S&P’s decision came at an odd time when many investors and analysts think the financial risks in China are easing, rather than increasing in recent months,” said Iris Pang, chief Greater China economist at the banking and financial services firm ING.

It also came in less than a month ahead of the 19th Party Congress, when China’s top party officials are facing a reshuffle, and as various measures were adopted to make stability a top priority.

The strong rally of the yuan earlier this month lifted the Chinese currency to the strongest position against the US dollar since December 2015. China’s central bank has since adopted some pro-market-oriented measures, including scrapping the reserve requirement in trading of foreign exchange forward contracts.

Guan Tao, a former senior official with the State Administration and Foreign Exchange (SAFE) and now an independent researcher, said last week that the yuan could realise a “clean float”-- essentially meaning free of government interference, within three years.

“But the S&P rating cut may affect Beijing’s pace in relaxing controls in foreign exchange trading and capital control, if market turbulence follows the surprising downgrade,” Pang said.

“It will definitely swing the confidence of some people, particularly those overseas, making them concerned about whether they have missed some looming risks in China’s economy, thus affecting their investment decisions,” she said, adding foreign investors will be “more hesitant to invest in Chinese bonds”.

Foreigners hold only about 2 per cent of China’s US$8.3 trillion bond market, a ratio lagging behind western markets and those in Japan and South Korea. The Chinese authority has been working to improve participation by foreigners by kicking off a bond connect scheme in July.

Scholars and analysts have been discussing reforms to further liberalise foreign currency trading, and further opening up the financial market to foreign players.

Last week, the People’s Bank of China reportedly held a meeting with the country’s top bankers to discuss whether to allow foreign companies to take majority stakes in financial joint ventures. The talks also focused on raising the current 25 per cent ceiling on foreign ownership of Chinese banks.

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Still, many analysts believe the impact from S&P’s downgrade of China’s sovereign rating will be minimal.

“So far, the market generally believes in the PBOC’s willingness and capability in maintaining market stability. While the weak US dollar is not incentivising short selling of yuan,” said Singapore-based analyst Zhou Hao at Commerzbank.

Traders generally shrugged off the S&P rate cut decision on Friday, as the yuan closed little changed at 6.5922 against the green back.

JP Morgan analysts led by Zhu Haibin argued in a note issued on Friday that China’s debt reducing campaign, also called “deleveraging” by the government, is progressing as planned.

“The latest data show that the second quarter was the first quarter in which debt declined since 2011,” the note said. “Although the decline in total debt is marginal, it is still worth noting for a few reasons. First, this is the first time since 2011 that total debt has declined. Second, the compositional shift, with household debt increasing, while government and corporates liabilities declined, points to some progress in debt restructuring,”