China Fumes Over Rating Agency Downgrade Warnings

An analysis by Michael Lelyveld
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IMF Secretary-General Lin Jianhai chats with People Bank of China Governor Zhou Xiaochuan (R) during the IMF and World Bank Group 2016 Spring Meetings in Washington, April 16, 2016.
IMF Secretary-General Lin Jianhai chats with People Bank of China Governor Zhou Xiaochuan (R) during the IMF and World Bank Group 2016 Spring Meetings in Washington, April 16, 2016.

China's state media have launched an all-out campaign against international bond rating agencies in an effort to counter negative economic reports.

Government officials have put a brave face on findings by Moody's Investors Service and Standard & Poor's Ratings Services, which changed their outlooks for China from "stable" to "negative" last month, citing higher economic risks.

On April 5, Fitch Ratings added another warning about China's rising debt, calling it "a mounting source of systemic vulnerability."

China's government battled back last week with the announcement of stable 6.7-percent growth in first-quarter gross domestic product from a year earlier.

The GDP rate for the period met expectations for China's "new normal," more sustainable economy, although it was down from the 6.8-percent pace in the previous quarter and the 6.9-percent growth for all of last year.

"China bears should now take a break," the official Xinhua news agency said in commentary. "New indicators have proved once again that pessimism over the Chinese economy is overplayed and misplaced."

Officials have also hailed an announcement by the People's Bank of China (PBOC) on April 7 that the country's foreign exchange reserves staged a slight gain in March after five months of declines.

Criticism suggests concern

Both were read as signs that the negative outlooks were inaccurate and unnecessary.

"We don't care much about the ratings," Finance Minister Lou Jiwei said at the China Development Forum in Beijing on March 20, the official English-language China Daily reported.

But the barrage of criticisms and commentaries in state media suggested otherwise.

Following the Moody's statement on March 2, officials and the press responded angrily with a flurry of objections and critical reports.

On March 4, Finance Vice Minister Zhu Guangyao accused the bond raters of acting under "ideological influences" and treating emerging economies unfairly, Xinhua reported.

"The move lacks foresight and vision, and practice will prove the decision wrong, as they should not make judgments on China based on Westernized perspectives," Zhu said.

The decision "does not tally with facts," Xinhua said separately, citing official think tank economists.

After the March 31 announcement by Standard & Poor's (S&P's), the press answered back with similar outcries.

The assessments were "overestimated," potentially misleading to global investors and not "objective," according to a series of reports.

Rebalancing proceeds slowly

Last week at a Group of 20 finance ministers' meeting in Washington, Lou criticized the rating agencies again, suggesting they were uninformed.

"Credit rating agencies do not know the specific Chinese economic situation," said Lou, as quoted by Xinhua. "I don't blame them because they don't know what's going on (on) the ground in China," he said.

The negative comment from Moody's landed days before the opening of China's annual legislative sessions, listing worries including "uncertainty about the authorities' capacity to implement reforms," rising debt levels, capital outflows and growth risks.

S&P's report followed the sessions and release of the 13th Five-Year Plan, concluding that "the country's reform agenda is on track" but that "economic rebalancing is likely to proceed more slowly than we had expected."

A central issue has been the government's willingness to deal effectively with the problems of indebted state-owned enterprises (SOEs), which have been slated for mergers, breakups or bankruptcies with a tightening of credit.

The negative finding was "partly motivated by our opinion that the pace and depth of SOE reform may be insufficient to attenuate the risks of credit-fueled growth," S&P's said.

Taken together, the reports were seen as signs of eroding confidence in the economy and the government's ability to manage it.

Although the three agencies retained their existing ratings for China, officials were clearly stung by the implications.

"It is a slap in the face and they're reacting, but maybe not in the right way," said Gary Hufbauer, senior fellow at the Peterson Institute for International Economics in Washington.

Characteristic caution on risk

Hufbauer said rating agencies have been generally "behind the curve" in responding to economic risk factors, using characteristic caution before downgrading sovereign debt.

Rating downgrades could potentially affect bond prices and borrowing costs, although analysts also argue that China should be relatively well-set with a current account surplus, substantial foreign exchange reserves and domestic bank deposits.

In its press statement, Fitch said that "China has the administrative and financial resources to avoid a disruptive slowdown to near-zero growth over the rating outlook horizon of about two years."

A Xinhua report focused on the positive parts of the Fitch findings, stressing that China has the resources "to avoid a hard landing," while omitting the reference to "near-zero growth."

Even the mention of such a drop could send shivers through markets. China 6.9-percent growth in 2015 was already the slowest pace in 25 years.

The negative changes in outlook are essentially warnings that rating downgrades may be coming. S&P's said that increasing economic and financial risks could lead to a downgrade "this year or next."

But even the advanced warning has triggered protests that China is being treated unfairly at a time when officials insist that the economy has already started improving, thanks to the government's reform efforts.

"Standard & Poor's and Moody's have overestimated the difficulties China is facing, while underestimating its ability to push forward with reforms and cope with risks," Finance Vice Minister Shi Yaobin said earlier this month.

In another pushback against the rating agencies last week, Xinhua cited an "upgrade" from the International Monetary Fund after the IMF raised its GDP growth forecast for China this year to 6.5 percent from 6.3 percent in January.

In the quarterly update to its World Economic Outlook, the IMF did not use the term "upgrade," saying instead that the "slightly higher" projection reflected "announced policy stimulus."

The IMF also raised its growth forecast for 2017 to 6.2 percent from 6.0 percent. Both figures remain below China's annual goals.

Government analysts cite more supportive figures, pointing to the March gain in the official purchasing managers' index (PMI) to 50.2 from 49 a month earlier, which reflected expansion with a pickup in manufacturing.

Home prices have shown more strength in a growing number of cities, according to official surveys, while growth in power consumption crept up in the first quarter to 3.2 percent.

March exports reversed a string of monthly declines with an 11.5-percent gain in dollar terms, although imports continued to slip, dropping 7.6 percent, according to China's customs data last week.

The first-quarter GDP results were within the government's target range of 6.5 to 7 percent for this year, offering further encouragement.

Problem or solution?

But the rating agencies have seen high GDP results as part of the problem for China, not the solution.

Under the Five-Year Plan, the government is seeking average annual GDP growth of 6.5 percent to make good on the Communist Party's pledge to double GDP and per capita income by 2020 compared with 2010.

In its analysis, S&P's said it expects GDP growth at or above 6 percent at least through 2019. But the higher target of 6.5 percent implies that the government will try to pump up the economy with more credit and allow SOEs to take on more debt.

"We believe that achieving this rate of growth will require credit growth to outpace nominal GDP growth in the period," it said.

Estimates of China's debt problem have varied.

According to Moody's, government debt last year rose to 40.6 percent of GDP from 32.5 percent in 2012 with a likely increase to 43 percent next year. Chinese economists argue that 40 percent is well within a safe range.

But last year, S&P's estimated that corporate debt had climbed to 160 percent of GDP by the end of 2014 from 120 percent a year earlier, Reuters reported.

In its outlook report, S&P's said it expects substantial growth in domestic credit as the government backs more investment to support the economy. Domestic credit is likely to rise from less than 160 percent of GDP this year to nearly 180 percent by 2019, it said.

Total credit in China, excluding equity raising, rose to nearly 200 percent of GDP last year from 115 percent in 2008, Bloomberg News said, citing official estimates.

Fitch said the "true figure" may be closer to 250 percent of GDP. An increase to 260 percent is expected this year, according to Bloomberg.

Whichever measure is used, there appears to be a consensus among rating agencies that debt levels are rising more than previously expected.

There are also diminishing returns from adding more debt in terms of economic growth.

"The discouraging fact ... is that it takes more debt to create a given increment of GDP now than it did five or 10 years ago," Hufbauer said.

Last week, the IMF added another warning on China's debt levels, estimating that China's commercial banks face risks on U.S. $1.3 trillion (8.4 trillion yuan) of loans to corporations that may be unable to pay.





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