China’s ratings misprice its risk; Hong Kong’s are spot on


Jeremy Weltman
Published on:

Disaggregating China’s investor risk into its constituent parts points to less safety in its sovereign bonds than its credit ratings suggest. Hong Kong is a different proposition with experts choosing to ignore its political problems.

On a total risk score of 61.08 out of a maximum 100 points, China ranks 38th on Euromoney Country Risk’s (ECR) global scoreboard, putting it towards the top of the third of five tiered categories equivalent to a BB+ to A- rating.

Its ranking has remained fairly stable in recent years, rising two places compared with a year ago, but down one place since the first quarter of this year.

Yet all three of the main agencies award a higher credit rating, with Fitch putting China on A+, and Moody’s and S&P agreeing on Aa3/AA-.

Five-year credit default swaps price in a lower risk of default in China compared with Mexico, two places higher in ECR’s rankings – with a spread of 77 basis points, compared with 83.

China’s ECR score has improved this year (by 1.2 points), but is still lower in comparison with 2010. All of China’s economic and most of its political risk-indicator scores have fallen during that time, reflecting the weakened growth outlook.

Barring one or two positive surprises on the manufacturing front, successive months of house price falls and other ‘slowdown indicators’ have sparked another drive to bolster liquidity.

Flemming Nielsen, senior analyst at the Danske Bank team taking part in ECR’s survey, says: “In our view, we are still in a phase of moderation in [Chinese] growth, driven by weaker credit growth and investment demand. Hence, we still expect the manufacturing PMIs to move lower in the coming months.”

Of the 15 risk indicators ECR’s panel of experts are regularly asked to assess, China’s hard infrastructure – one of four structural risk sub-factors – scores highly, reflecting the substantial public investment powering its economic development.

However, China’s expansion has relied too much on credit-driven investment and is showing signs of waning over the medium term, requiring a faster pace of reform. Its demographics and labour relations remain challenging – the former in terms of longer-term welfare and state-pension sustainability, which has yet to be properly addressed.

An Organization for Economic Cooperation and Development (OECD) regional report notes the progress made in terms of improving the fiscal and administrative procedures in China, but goes on to detail various institutional shortcomings, including the lack of guidelines and transparency at the local government level.

Low scores for corruption and transparency (hovering below 4.0 out of 10 points available) are unsurprising in that regard, but highlight the risks for bank stability, which scores 5.2 out of 10 in the ECR survey, compared with 6.6 for Mexico, as shadow-banking practices weigh on its risk profile.

The OECD attaches “great concern to the growth of illicit local-government guaranteed debt”, much of which is bank borrowing by local government financing vehicles, and officially estimated at Rmb20 trillion (40% of GDP) in 2012, double the figure stated two years earlier.

Hong Kong a different proposition

Hong Kong, on the other hand, receives a score of 79.88, placing it 12th on the global rankings, just inside tier one, the highest ECR category denoting an AA ranking or above, in line with Fitch (AA+), Moody’s (Aa1) and S&P (AAA).

The special administrative region has received considerable publicity in the light of Beijing’s interference in its elections process for chief executive. Naturally, the Communist Party wishes to promote a China-friendly candidate for the post, but this has provoked considerable tensions, with mass protests taking place both in favour of China and against, in what has been dubbed a “David and Goliath” democracy battle.

Slower growth on the mainland and across the wider southeast Asia region would also be expected to deliver negatives for its trade-driven economy.

However, Euromoney’s experts deem the risks of government non-payment/non-repatriation to be extremely low in Hong Kong (scoring 8.9 out of a maximum 10 points available), a factor invariably linked to the high score for its government finances (8.8 out of 10).

The territory has run a prudent budget surplus for six years and is a strong net external creditor, with a current-account surplus and fiscal reserves worth slightly more than a third of GDP. With a strong and predictable currency board regime, all of these factors should stand Hong Kong in good stead to withstand any possible banking sector or real-estate-related imbalances.

This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.