Tag Archives: credit rating

Politics, Not Debt Will Drive The Deleveraging Of China’s SOEs

MOODY’S CREDIT DOWNGRADE of China caught the attention of the public prints, ever ready, in some quarters at least, to see the prophesied hard landing just around the corner, with the economy crumpling under the weight of an oncoming rush of bad debt. S&P did much the same as Moody’s back in March with much less general notice. In its commentary, Moody’s falls over itself to emphasise the long-term nature of the risk.

As this Bystander has argued before, while China’s debt-to-GDP ratio is large, and has grown in recent years, it remains manageable by Beijing, even in the event of a crisis, and the risk of external contagion is small.

That is not to say it is not of concern to policymakers. It is. It is concentrated in state-owned enterprises (SOEs) and local authorities. SOE debt, at 115% of GDP is concerning. (In Japan and South Korea state-owned corporate debt is about 30% of GDP). And the finance ministry has noted that some local authorities, caught between paying for shutting down loss-making state industries or subsidising them to keep them going, and no longer able to rely on land sales to square their books, are struggling to cover operating expenses.

All this is also a sign, widely commented on by the likes of the IMF, World Bank and the OECD, that the old-school means of state-led infrastructure investment to keep growth going are persisting to the detriment of ‘rebalancing’.  Those two points come together politically.

The political event of the year is, self-evidently, the Party plenum to be held later this year. This is no ordinary plenum, as it is the scene-setter for the next generation of leadership. President Xi Jinping’s legacy is at stake.

Vested interests lying in the way of economic reform have not been fully removed by the anti-corruption campaign. Many of those same interests would also end up on the wrong side of any aggressive debt resolution, given both the individual companies that would be involved and the structural reforms necessary to governance and financial markets.

So, for now, authorities are biding their time over the debt question. The economy has stabilised sufficiently to buy them a few more months of inaction; candidate Trump’s threatened trade war has been headed off; the razzmatazz around One Belt, One Road sustains hopes of new export markets for excess capacity.

Once Xi has consolidated his political control at the plenum, then the debt busters will start to move in.



Filed under Economy, Markets

China’s Big Banks’ Wealth Management Products Raise Concerns

An often overlooked red flag about the creditworthiness of China’s big state-owned banks was raised by Fitch Ratings on Monday. In a report reaffirming the ratings of the Industrial & Commercial Bank of China, China Construction Bank, Bank of China, Agricultural Bank of China and Bank of Communications, the U.S. credit rating agency noted:

One key risk over the short-term is Chinese banks’ rapidly growing wealth management offerings, of which state banks are the leading issuers. At end-Q1 12, Fitch estimates that the amount of outstanding wealth management products in the banking system reached 10.4 trillion yuan ($1.6 trillion). While this represents a relatively low 12% of total deposits, an estimated half of all new deposits are raised through these products. Poor matching of the maturities of the liabilities with the assets underlying the products means banks often do not have money coming in on the products to repay investors upon maturity. Instead, banks often rely on new issuance or product rollovers to repay investors.

This is a different concern to the more common one about the quality of the banks’ loan books in the wake of the credit-fueled stimulus splurge that followed the 2008 global financial crisis which saw the banks’s credit exposure growing twice as fast as nominal GDP in the three years to the end of last year. That widening gap raises questions about borrowers’ ability to repay as these loans fall due this year and next, especially as the economy slows. We are already seeing the big banks showing great forbearance, especially to local government borrowers, and dutifully finding ways to keep those pressures on asset quality from showing up in higher non-performing loans numbers.

The expansion of wealth management products threatens the big banks less with solvency issues and more with funding and liquidity ones, given how important this activity has become to deposit growth. True, as Fitch acknowledges, the banks’ state backing, strong deposit networks and 19% capital reserve ratios provide “substantial resources” to absorb increasing funding or liquidity strains were there to be a disruption to the wealth management business. And if the worst came to pass, Beijing would likely shore up the balance sheets of  failing institutions, as it has shown itself willing to do in the past. But it could be bumpy. What happened in the informal banking sector in Wenzhou provides a microcosmic reminder of what can go wrong when a slowing economy can’t keep up with the race for yield.

It is worth remembering that four China’s five biggest state-owned banks rank among the six largest banks in the world. Just as their sheer size means credit losses could be significant, so the volume of the wealth management business means a disruption of it could put pressure on China’s sovereign credit rating should Beijing have to provide material support.

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Washington’s Downgraded Debt And Beijing’s Tied Hands

If past is prologue, then the criticism heaped on Washington by China’s state media earlier this week for its handling of its debt-ceiling debacle was mere throat clearing for the lambasting of America’s “addiction to debt” that followed credit rating agency Standard & Poor’s controversial downgrading of the U.S.’s credit rating to AA+ from AAA. From Xinhua:

The days when the debt-ridden Uncle Sam could leisurely squander unlimited overseas borrowing appeared to be numbered as its triple A-credit rating was slashed by Standard & Poor’s (S&P) for the first time on Friday…

Dagong Global, a fledgling Chinese rating agency, degraded the U.S. treasury bonds late last year, yet its move was met then with a sense of arrogance and cynicism from some Western commentators. Now S&P has proved what its Chinese counterpart has done is nothing but telling the global investors the ugly truth.

China, the largest creditor of the world’s sole superpower, has every right now to demand the United States to address its structural debt problems and ensure the safety of China’s dollar assets…

The U.S. government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone.

It should also stop its old practice of letting its domestic electoral politics take the global economy hostage and rely on the deep pockets of major surplus countries to make up for its perennial deficits.

However, Beijing, for all it’s righteous indignation, faces what economists call the bank-loan problem. If you owe the bank $100 that you can’t repay, then you have a problem. But if it is $1 million that you owe, then it is the bank that has the problem.

Beijing is Washington’s banker right now, holding some $2 trillion of dollar-denominated assets. No one in Beijing thinks Washington will walk away from its debt. Nor can they want to. The collapse of the global financial system in that event would be beyond the repair of any amount of administrative guidance and Party discipline.

But China does need to do what it can to preserve the value of it’s dollar-denominated assets. Dumping them in a fire sale would only leave scorched earth. Diversifying into other currencies has been happening but it is only feasible to do at a measured pace and the alternatives to the dollar are in practice not particularly more attractive. The euro has a sovereign-debt crisis of its own and there are precious few, if any, other fully convertible currencies whose nations could absorb the volumes of capital flows and potential macroeconomic instability that would be involved. Beijing has little alternative at this point to sitting and fulminating.

One day, it’s own currency might be a reserve currency, but there is an awful lot of financial reform to be undertaken in China before that day comes to pass (and we are not sure it will come soon). In the meantime, Beijing has been promoting the greater use of the IMF’s Special Drawing Rights (SDRs) as a surrogate international reserve currency that could challenge the dollar’s primacy in that role. Hence, slipped in to Xinhua’s commentary:

International supervision over the issue of U.S. dollars should be introduced and a new, stable and secured global reserve currency may also be an option to avert a catastrophe caused by any single country.

There is no way, even in these deficit-reducing times, that Washington would accept anyone’s but it own control over its printing presses. And turning the SDR in to something that could even share the role of the world’s reserve currency is a long, long way off. Disheartening as it may seem, Beijing’s best hope is that Washington gets its fiscal house in order, and, longer term, that it progresses with it’s own structural reform to make its economy more dependent on domestic demand and so reduce the global macroeconomic imbalances that are underpinning the U.S.’s deficits.

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A Disdainful View From Beijing On America’s Debt Ceiling Debate

China has made little secret of its disdain for the way the U.S. political establishment has handled the debate over raising the federal government’s debt ceiling. These extracts from an article carried by Xinhua captures the tone:

The months-long tug of war between Democrats and Republicans, however, failed to defuse Washington’s debt bomb for good, only delaying an immediate detonation by making the fuse an inch longer…

Meanwhile, the madcap farce of brinkmanship has disclosed yet another ticking bomb in the heartland of the sole superpower in the world — the crippling tendency to politicize the economics while trivializing the politics…

Should Washington continue turning a blind eye to its runaway debt addiction, its already tarnished credibility will lose more luster, which might eventually detonate the debt bomb and jeopardize the well-being of hundreds of millions of families within and beyond the U.S. borders…

Whether Washington’s political elite, intent on grabbing maximum political gain, intended the chaos or not, it is advisable that one should not mess around on the edge of an abyss. Given the heft of the United States, such a dangerous practice is tantamount to a bomb of mass destruction. If left unattended, it might explode, and the whole world will have to deal with the shock waves.

Meanwhile, while Americans wring their hands over whether their credit rating agencies will downgrade their country’s AAA rating despite the deal the U.S. Congress has passed, Chinese rating agency Dagong has gone ahead and done so. It downgraded the U.S.’s credit rating from A+ to A, with a negative outlook. China is the largest foreign holder of U.S. government debt, at $1.15 trillion in May. It has been trying quietly to scale back the growth in its exposure, though, truth be told, with the euro in crisis, it doesn’t have a lot of overly attractive alternatives so is stuck with what it has got.


Filed under China-U.S., Economy

China Responds Awkwardly To U.S. Debt Warning

The longer Beijing waits to say something the more it usually means that it doesn’t know what to say. In the case of the U.S. credit rating agency S&P’s decision to lower its outlook on U.S. government debt to negative from stable (its remains a AAA credit), it might have been better saying nothing at all. Japan, the U.S.’s other large creditor nation along with China, and even South Korea quickly offered words of support for Washington. By comparison, Beijing’s response, now it has eventually come, inserted into the transcript of a routine briefing where the issue wasn’t mentioned, sounds mealymouthed. “We hope the U.S. government earnestly adopts responsible policies and measures to protect the interests of investors,” the foreign ministry posted on its web site, adding that it had “taken note” of S&P’s announcement. Awkward.


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