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article imageChina disputes Moody's downgrade of its credit rating

By Ken Hanly     May 27, 2017 in Business
Moody's credit rating service has downgraded China's rating by one notch to A1. The company claimed that although structural reforms will slow the build-up of debt it will not stop debt growth.
Unless China is able to get its growing deficit in check it could it could see another credit downgrade in the future. The company predicted that the financial strength of China will be eroded in coming years as growth slows while debt increases. However, at the same time as it announced the downgrade Moody's changed the outlook on China from negative to stable indicating that it is unlikely to change the rating for some time.
China was quite critical of the downgrade arguing that it was based upon "inappropriate methodology" and that it exaggerated difficulties as well. China also complained that the report did not adequately take into account the country's reform efforts. A senior Moody official, Marie Dixon said that the company was encouraged by the vast reform agenda undertaken by China designed to address the debt problem. However, she said that the company thought that while the measures would slow the growth of debt they would not halt its growth and there will be no dramatic drop in the level of debt. She said that China's economic recovery last year was mostly caused by pump-priming measures meant to reach growth targets. This added to the country's debt.
The company also wants to see to what extent policies designed to rein in local spending are actually carried out according to the associate managing director of Moody's Sovereign Risk Group. Li Xiujun, vice president of credit strategy and standards at Moody's said: "If in the future China's structural reforms can prevent its leverage from rising more effectively without increasing risks in the banking and shadow banking sector, then it will have a positive impact on China's rating.If there are signs that China's debt will keep rising and the rate of growth is beyond our expectations, leading to serious capital misallocation, then it will continue to weigh on economic growth in the medium term and impact the sovereign rating negatively. China may no longer suit the requirement of A1 rating." Moody's expects GDP growth in China to be around 5 percent in coming years, down from 6.7 percent last year making it even more difficult to reduce debt.
The government stimulus policies have resulted in a mountain of debt with credit growth now running at nearly 300 percent of GDP when debt at all levels are included. The growth in government and quasi-government debt is estimated to have risen from 62 percent in 2015 to 68 percent in 2016. Corporate debt also increased from 153 percent of GDP in 2015 to 164 percent in 2016. Many analysts fear there could be a banking crisis in the future as there are more and more loans that are unpaid.
China has used debt to equity swaps, reducing industrial capacity, and reforms of state-owned enterprises as ways of lowering debt levels. The central bank has raised short-term interest rates to discourage borrowing. However, the moves have been cautious in an attempt not to roil the political waters before the Communist Party Congress in the autumn this year.
The Moody's lowering of China's debt rating is the first in nearly thirty years. The Chinese are upset partly because it will make it more difficult to raise capital on equity and bond markets. The downgrade was from Aa3 which is high quality and very low risk to A1 which is medium to high quality and low risk. The last downgrade was in the 1990's. Since then there have been many upgrades as China experienced rapid growth and emerged as a rising global economic power.
A main problem is that China's economic growth has not been larger than its GDP growth since back in 2009. China's problem is that whenever the growth level falls below what the authorities wish for they spend more money to stimulate the economy and that counteracts any attempts to lower debt levels.
Earlier this year at Davos, after China's GDP figures improved generating a wave of optimism, president Xi Jinping was hailed as a savior or a potential savior. In an era when there is a reaction to global trade expansion as evident in the rhetoric against trade agreements by Donald Trump, Jinping was an antidote to rising isolationism in some jurisdictions. It looked as if China was tackling its debt, until recent figures were disappointing and China appears addicted to credit growth. While Chinese officials try to reassure investors and others that the situation will work out in the end, Moody's downgrade is but one indication that China's debt problem is not solved. As a recent article concludes after suggesting that there may be some basis for comparing Japan in the early 1990's with the China of today: Indeed, for the growing sleuth of China bears out there, mooching around on the margins of the business pages and the less visited corners of the Internet, China's economy is metaphorically somewhere between a runaway train and the creaking timbers of a viaduct called "Cassandra's Crossing". Moody's has just, tentatively, hesitatingly, "inappropriately" even, suggested that the old, blind, Greek woman may be onto something.
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