Tuesday, May 30, 2017

China’s ratings downgrade, explained

Keith Bradsher

May 26, 2017

BEIJING — Moody’s Investors Service downgraded its rating of China’s sovereign debt one notch on Wednesday (May 24), citing concerns over growing debt in the country, which has the world’s second-largest economy. In recent years, as China’s stunning economic performance of past decades has become difficult to sustain, the country has used debt to fuel growth.

Now, Moody’s says that China will have to borrow more and more to maintain the levels of economic growth the government wants. The concerns Moody’s raises will sound familiar to those who follow the Chinese economy closely. Expressed by one of the world’s top credit ratings agencies, however, the misgivings will be harder to ignore.


In short: China has a lot, and has accumulated it very fast.

When it comes to pumping money into a financial system, China has made the Federal Reserve in the United States and the European Central Bank look almost lackadaisical. It has expanded its broadly measured money supply by more than the rest of the world combined since the global financial crisis. Now it has 70 per cent more money sloshing around its economy than the US does, even though the US economy is bigger.

China has accumulated its towering debt remarkably quickly. Goldman Sachs looked last year at how fast debt had accumulated relative to the size of the economy in 55 countries since 1960. It found that by the end of 2015, China was already in the top 2 per cent of all credit expansions – and its debt shot up even higher last year. All of the other large expansions occurred in very small economies, some of which essentially lost control of their finances.


The incredible part is that Goldman Sachs acknowledges that its calculations may underestimate the extent of China’s debt buildup.

That’s because Goldman’s calculations exclude what is often called shadow banking, a little-regulated, murky area of finance outside traditional banking channels in which China has also emerged as a world leader.

Bank lending jumped 10 per cent last year in China. But, over the same period, investments known as wealth management products, a speculative category of loans and other investments that banks keep off their balance sheets, zoomed up 30 per cent.


More than half of the bank debt in China consists of loans from state-owned banks to state-owned enterprises.

The banks are not going to cut off lending to even the most debt-ridden state-owned enterprises. Already, economic growth is showing some signs of slowing after a strong start in the first three months of this year. Tighter lending policies could result in factories closing and in unemployment, as well as in defaults on previously issued loans.


Chinese families and companies might start smuggling more money out of the country, further weakening the financial system. China has US$3 trillion (S$4.14 trillion) in foreign reserves to counter that, but even that large sum would not last forever.

A trade war with the US could mean fewer dollars coming into China to offset money headed abroad, though President Donald Trump is no longer using the type of language about trade with China that he did on the campaign trail. But if a trade war were to break out anyway, that could undermine public confidence in the economy.

If China’s residential real estate prices tumble, construction companies and developers may be unable to repay their debts, which could also hurt banks.


It could accept a lower pace of economic growth, but that might risk fewer jobs for its vast workforce.

It could bail out the banking system, but that could lead its borrowers to believe that the government will always be there to rescue them.

Or it could do nothing, and hope its debt does not weaken the economy further or create a broad financial crisis someday. 


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