China economy

Four reasons why China’s credit rating downgrade matters

Agency made ‘wrong decision ... ignored the country’s sound economic fundamentals’, finance ministry says

PUBLISHED : Friday, 22 September, 2017, 2:32pm
UPDATED : Monday, 25 September, 2017, 2:56pm

International rating agency S&P Global has downgraded China’s sovereign credit rating, citing the country’s growing debt risks.

China’s finance ministry said on Friday the move was the wrong decision and that the agency had ignored the country’s sound economic fundamentals and development potential.

Another ratings agency, Moody’s, downgraded its crediting rating for China in May, also citing concerns about growth and levels of debt.

So what will be the impact of the latest downgrade?

1. Government narrative questioned

A sovereign credit rating downgrade is a small public relations crisis for the Chinese government. Beijing is sparing no efforts to try to convince domestic and overseas audiences that the Chinese economy is doing fine and what problems exist are being dealt with properly.

The downgrades by S&P and Moody’s cast doubts on Beijing’s rhetoric.

2. Higher lending costs

There is no concrete data to show the financial cost of any downgrade on Chinese government bond issuance abroad. China’s finance ministry plans to sell 14 billion yuan (US$2.1 billion) in yuan denominated bonds and US$2 billion in dollar denominated bonds overseas this year, and the Chinese government could be forced to pay more if investors factor in the downgrades and demand higher interest rates.

‘Wrong decision’ in downgrading China’s credit rating, finance ministry says

A sovereign ratings downgrade could also translate into higher financing costs for a group of Chinese state-backed enterprises and institutions when borrowing abroad. Chinese enterprises raised US$127 billion by selling dollar bonds to overseas investors last year and many of the issuers could be affected indirectly by the ratings downgrade.

Moody’s, for instance, downgraded 39 Chinese enterprises after it cut China’s credit rating in May.

The overseas financing cost of the Industrial and Commercial Bank of China and the Bank of China, two state lenders, rose 20 to 30 basis points after Fitch Ratings, another ratings agency, downgraded China’s sovereign rating in 2013, according to a local brokerage firm Tianfeng Securities.

3. Tougher job to woo investors

A sovereign rating downgrade is a kind of vote of no confidence in China’s economic prospects and Beijing’s capabilities to manage risks. It will increase the difficulty for the Chinese government to woo foreign investors to put money in China, whether it is a greenfield factory project or the onshore bond market.

China’s inbound foreign direct investment dropped by about six per cent in the first seven months of this year and the Chinese leadership under President Xi Jinping is redoubling efforts to woo overseas investors.

Does Fed’s latest move add urgency to Beijing’s financial rescue mission?

China has also opened its onshore bond market to foreign investors through a Bond Connect programme with Hong Kong, but a twin sovereign rating downgrade may make investors more cautious in entering the Chinese market.

4. Fresh reason to bet against the yuan

The Chinese government has adopted draconian capital account controls to stem an exodus of capital and to engineer a modest appreciation of the yuan against the dollar.

The downgrade by S&P, along with the Moody’s downgrade in May, could undermine the fragile confidence in the Chinese economy and its currency, especially when the Federal Reserve has announced a programme of interest rate rises and the sale of bonds.

It could, in turn, lead to the further flow of cash overseas and put more pressure on the value of the yuan.