Country risk: The compelling case for a China downgrade


Jeremy Weltman
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Talk of a crisis is overblown, but the world’s most populous nation is still struggling to convince the experts, as its risk score declines.

China escalator-R-600

The announcement from Moody’s earlier this month of a changed outlook on China’s Aa3 credit rating from stable to negative is understandable.

China lost 1.3 points from its total risk score in Euromoney’s country risk survey in 2015 in response to concerns surrounding the fortunes of the world’s most populous nation.

It has failed to improve its standing since the global credit crunch of 2008, with the economy now transforming and slowing.

Moody’s cited the weakening fiscal metrics, including China’s rising government debt and “large and rising contingent liabilities on the government balance sheet”.

Reserve buffers are falling due to capital outflows, and there are doubts over the capacity to implement reforms.

China is now so close to Italy in Euromoney’s global rankings the two are broadly equivalent in risk terms.

In fact, China beats Italy on just four of the 15 risk indicators surveyed as of March 2016:

The scores for China’s debt indicators and access to capital are also lower than Italy’s, raising the question as to why China is still Aa3/AA-, based on Moody’s and S&P’s ratings, or even A+ according to Fitch, when Italy is rated triple B.

In context

China is not about to lurch into crisis. The IMF is predicting 6.3% real-terms GDP growth for 2016 and 6% for 2017, which is higher than most advanced economies, albeit down from 6.9% in 2015.

And yet all five of its economic risk factors were downgraded last year, notably the GNP outlook indicator as economic forecasts were successively downgraded.

The IMF’s predictions, moreover, suggest the government’s 6.5% to 7% target range will not be met.

Currency and equity market volatility, causing the authorities to employ various tactics to bolster confidence and limit the capital outflow, appear to have worked to an extent, but might not be enough, and speculation is rising the regional regulators must act to curb real-estate financing to cool the urban property market boom.

Managing such a large economy remains difficult and China’s policymakers still have a tendency to veer from market reforms in the pursuit of stability.

Arjen van Dijkhuizen, senior economist at ABN Amro, says the government will loosen fiscal policy to ensure the economic slowdown is gradual, raising the deficit to 3% of GDP in 2016 from 2.3% last year – although it is worth bearing in mind the fiscal black hole is much larger when substantial off-budget accounts are included.

The country has ample fiscal and foreign-exchange buffers, but its “high and rising debt levels remain one of the key risk factors”, says Van Dijkhuizen, adding that this is “presenting a difficult balancing act between stabilizing growth and preserving financial stability, including the longer-term requirement for deleveraging”.

China’s country risk score has fallen slightly further in 2016 based on provisional survey results for the first quarter of the year, with experts downgrading scores for monetary policy/currency stability, government finances and the regulatory and policy environment.

The final survey results are due for release early in April.

As the world copes with the effects of a slowing China on commodity prices and global growth prospects, the sovereign’s creditworthiness remains questionable, and it surely won’t be long before Moody’s must act.

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