With ratings downgrade, Moody’s has failed to see the whole picture

You can’t accuse Moody’s of pandering to China. Just as Beijing has signed a new bilateral trade pact with the United States that will allow, among other things, foreign ratings agencies into the mainland market, Moody’s has cut the country’s sovereign credit rating for the first time in 25 years. It then quickly followed with a downgrade of Hong Kong’s local and foreign currency ratings and the credit ratings of 26 state-owned enterprises on the mainland. Among these are household names such as China Mobile and Sinopec. Getting a notch down is not a significant downgrade but predictably, both the central and Hong Kong governments are upset and have issued detailed rebuttals.

It has been an especially bad time as China is planning to launch the so-called bond connect to encourage outside investment in the domestic credit market. Global investors and policymakers are, understandably, concerned about the direction the Chinese economy is moving. The challenges it faces are real. Foreign investment slowed to about 4 per cent growth last year, compared with 5.6 per cent in 2015. But this has many causes, among which is an economic transition from manufacturing to consumption and from cheap labour to a value-added hi-tech workforce.

So while Moody’s adjusted ratings reflect justifiable concerns, they don’t necessarily serve as a good indicator of the country’s capacity for economic reform or its fundamentals. The Ministry of Finance has provided a reasoned rebuttal that should go some way towards allaying the fears of foreign investors. It argues that Moody’s has not adequately recognised the economy’s “steady upward momentum”, which hit a higher than expected 6.9 per cent in the first quarter, and that China’s structural reforms take time but are bearing fruit. It also claims Moody’s and other foreign agencies may not fully understand measures set up to rein in the contingent liabilities of state-owned companies and the financing vehicles of many local governments.

Meanwhile, Hong Kong’s downgrade is collateral damage, as Moody’s argues it is directly related to the city’s increasing economic ties with the mainland economy such as the stock connect and the soon-to-be bond connect. Even more important is the belt and road international trade initiative, in which Hong Kong is expected to play a significant part. But as Financial Secretary Paul Chan Mo-po has pointed out, despite growing integration with the mainland, Hong Kong’s unique competitive advantages such as its legal system and financial services still mean the city deserves a premium rating.

Credit ratings provide a simple but useful road sign for investors and lenders. But they don’t absolve the need to understand complex mixed economies like China’s.