The Downgrade Nobody Is Talking About: China’s Negative Credit Ratings And Consequences

Like India’s PSU banks owning up to its humongous NPA problem that involves practically the Who’s Who of Indian business and Industry, alongside its medium to small players, China too is also facing up to its massive debt now.

China had also hidden it away, undifferentiated between the recoverable and the bad debt, so far, under multiple headings and separations between central, provincial, and local government.

But, along with the worrisome news flow from China’s opaque financial system, there are increasing global concerns on whether it will be able to manage its economy without dreaded severe dislocation. These, if they come, will have a serious knock-on effect, a new financial tsunami, sweeping over an already battered and fragile world economy. The impact on the one and a half billion Chinese people themselves could be devastating.

Could a Chinese financial collapse trigger a new recession/depression far worse than 2008? Yes, it definitely could.

Is there any chance of an implosion? It depends, as it has, in the West, on the sheer size of its bad debt, from its decades of borrow-and- spend state run growth. How much is still hidden away?

There have already been a number of steep and unprecedented falls in the Chinese stock markets where the people punt, and quite a bit of involuntary devaluation in the Chinese external currency, the Yuan.

The Chinese government has responded with cuts in the bank reserve ratios, rendering them more precarious in effect, and arbitrary containment actions on the bourses, to try and artificially break the fall and control the rates of descent.

So far, they seem to be coping, but it is difficult to gauge the extent of the rot. China had already been firmly down-graded to ‘Negative’ from ‘Stable’ by the important international credit rating agencies: Moody’s and Fitch on 2 March 2016.

This was an important marker of international sentiment and outlook for the $12 trillion economy. But the revision in financial confidence was largely resented and criticised as an over-reaction by Chinese officials and insiders themselves.

Still, the downward ratings early in March seemed to assert that whatever the Chinese authorities have been doing to fix their economy over the last year, has not delivered up to expectations.

And this downgrading has been applied to China’s credit rating for its government borrowing programme in bonds, both from the mainland and Hong Kong, as also, as of the 31 March, more ominously, to its overall sovereign rating.

The revised rating will have a profoundly negative effect on China’s ability to borrow at favourable rates of interest. It will also put considerable pressure on the value of its currency.

China says that its present credit ratings still best those of any others in the region, though it no longer compares with the larger and stronger US economy, that is actually growing again.

A more or less universally negative credit rating has been applied to the second largest economy in the world though for the very first time, and there are comments that this could be extended further if things do not improve.

Reasons being cited by Standard & Poors (S&P), Moody’s and Fitch, among the biggest and most respected credit rating agencies, include ‘deteriorating fiscal strength, falling foreign currency reserves, and uncertainty about Beijing’s commitment to reforms’. There is also criticism of further and new rising debt and enhanced capital outflows.

The rich Chinese are buying properties abroad, and moving their money out of the country. The first to cut forecasts on China’s future outlook on 2 March were Moody’s and Fitch. They have now been joined, on the 31st by S&P, which has cut China’s sovereign credit rating to ‘negative’ from ‘stable’, while holding its credit rating at –AA.

It did likewise for specially administered Hong Kong, moving the outlook to ‘negative’ from ‘stable’ as well, though once again retaining its credit rating for the island’s paper at AAA.

Criticism of these moves has come also from certain experts and economists from within China, over this month, who say enough notice is not being taken of the efforts to re-calibrate the economy for sustenance over the medium term. But the fact is, China’s economy is operating at ‘a 25 year low’, and there are massive challenges, given the weak state of the global economy as well.

By way of contrast, despite a sharply slowed Indian economy in the 2012-2013 period, still struggling to find its stride in 2016, a negative credit or sovereign rating has never come to visit so far. Of course, India’s economy is only valued at $2 trillion. It is a minnow economy, with little leverage beyond its already compromised banking system, unlikely to have too much of an international impact either way.

But its relative good health due to conservative management, and the size of its large domestic market, is attractive. This is especially true at a time when all other large economies are either stagnating or growing weakly. Today, India is, as is frequently pointed out, growing faster than China, and is, bizarre as it may sound, versus the on-the- ground lack of evidence, the fastest growing economy in the world.

India is clocking its GDP at some 7-7.5 percent. It gets points for its rectitude and discipline, deciding to stick to its fiscal deficit target of 3.5 percent of GDP, and also enjoys an admirable current account statistic. It also has fairly buoyant foreign exchange reserves in the region of $ 350 billion. It is expected to resume cutting interest rates in the next RBI review slated for 5 April, given a stable inflation scenario. The rupee is not sliding quite as fast as it was against the US dollar either, and it is fixing its banks.

The difficulties it faces are a much slowed economy, except for government investment in infrastructure. There is no new investment cycle emerging as yet, slow exports, a moribund stock market, very little new job creation, and not much progress as yet on ‘Make in India’ or indeed on structural reforms. Still, in a comparative scenario with the region and the world, there are several Indian initiatives that should bear fruit shortly including the benefits of increased FDI and greater governmental momentum.

China’s re-rating could certainly send more foreign institutional investment towards India, as long as both economies keep their heads above water, and China makes no big, swamping wave, of it.