1. Economics
September 21, 2017

Why China’s sovereign credit rating was cut and why it doesn’t matter

By Billy

Standard & Poor’s has fallen into line with its rival ratings agencies Moody’s and Fitch and cut China’s sovereign credit rating by one notch, down to A+ from AA-.

It’s the first time since 1999 S&P has cut the country’s rating, citing the risks from soaring debt. It also revised its outlook to stable from negative.

The move was well telegraphed with S&P saying in June there was a “real” chance of a downgrade and a decision would be made based on whether China is able to move away from a credit-driven growth strategy.

Clearly it has not. The IMF said in August it expected China’s total non-financial sector debt to rise to almost 300 percent by 2022, up from 242 percent last year.

I has been widely reported that state-controlled banks have been funnelling big loans to chronically money-losing state-owned companies, allowing them to avoid layoffs.

The agency said in a statement:

The recent intensification of government efforts to rein in corporate leverage could stabilise the trend of financial risk in the medium term. However, we foresee that credit growth in the next two to three years will remain at levels that will increase financial risks gradually. We expect such a trend to weaken the Chinese economy’s resilience to shocks, limit the government’s policy options, and increase the likelihood of a sharper decline in the trend growth rate.

Fitch lowered China’s rating in 2013, while Moody’s did so just last May. Last year a record number of countries were downgraded by Fitch, Moody’s and Standard & Poor’s.

Why now?

The timing of the move — while not at all unexpected — has raised eyebrows.

It comes just weeks ahead of a twice-a-decade Communist Party Congress (CPC), which will see a key leadership reshuffle and the setting of policy priorities for the next five years.

The Chinese government — and president Xi Jinping especially — will likely be particularly upset with S&P.  Xi has made political and economic stability the country’s top priority in the months leading up to the congress.

That has included allowing the state-controlled banking system to continue, and even expand its already heavy lending since midsummer, while a modest effort in late spring to limit the growth in lending has been pursued with less zeal.

The congress is expected to reconfirm Xi as the country’s core leader and will choose some new top officials to serve with him. This is unlikely to change but will be a dampener on the event.

Many have been impressed with China’s economic performance in recent months.

The world’s second-biggest economy surprised economists by matching its first quarter 6.9 percent expansion again in the second quarter. Economists surveyed by Bloomberg this month project growth will remain above six percent through 2019.

Andrew Polk, co-founder of research firm Trivium China in Beijing, told Bloomberg:

It’s bad optics for China, especially when they’re out there from a policy and rhetorical standpoint talking about debt more and acknowledging their debt challenge. It may feel like potentially the international community is piling on and that will be frustrating.

Does it matter?

It would appear not. China’s stock markets had closed before the downgrade, and there was little reaction in the yuan currency.

Ken Cheung, senior Asian FX strategist at Mizuho Bank in Hong Kong, told Reuters:

The decision was a catch-up with the other two credit agencies, instead of an initiative. Its impact on financial markets would very limited. For those invested in yuan-denominated bonds, they care more about yuan expectations. The downgrade decision is likely to have limited impact on capital inflows as well.

More importantly however, investors are increasingly brushing off the actions of rating agencies.

Credit ratings are intended to let investors know how likely a borrower is to repay their debts. But the size of the agencies, and the fact that borrowers pay for ratings, has been heavily criticised in the wake of the financial crisis and the European sovereign debt crisis.

Edwin Gutierrez, senior portfolio manager at Aberdeen Asset Management, told the FT in the aftermath of the UK losing its AAA credit rating last year:

We don’t give credibility to it. We use our own research.

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