Econintersect: Simon Rabitvitch (Financial Times) has an article documenting auditor concerns of excessive local government debt in China that can never been repaid. According to Rabinovitch it is rare for a figure as established in the Chinese financial industry as Mr Zhang (Zhang Ke of accounting firm, ShineWing, vice-chairman of China’s accounting association) to issue such a stark warning. Mr. Zhang used words such as “very dangerous” and “refused to sign off” on debt which he said would have applied to local governments that “don’t have strong debt servicing abilities“.
A week ago Fitch downgraded China’s long-term credit ratings as follows (from Fitch press release):
Fitch affirmed China’s Long-Term Foreign Currency Issuer Default Rating (IDR) at ‘A+’ and downgraded the Long-Term Local Currency IDR to ‘A+’ from ‘AA-‘. The Outlook is Stable. The Short-Term Foreign Currency IDR was affirmed at ‘F1’ and the Country Ceiling at ‘A+’.
Yesterday (16 April 2013) Moody’s issued a slight downgrade in outlook from positive to stable for China’s government bond rating. The Aa3 rating was affirmed.
Following is the complete press release from Moody’s:
Moody’s affirms China’s Aa3 rating; changes outlook to stable
Global Credit Research – 16 Apr 2013Singapore, April 16, 2013 — Moody’s Investors Service has today affirmed China’s government’s bond rating of Aa3 and changed the outlook to stable from positive.
The primary reasons for affirming the Aa3 rating and assigning a stable outlook are:
1) China’s credit fundamentals remain consistent with a Aa3 rating, underpinned by continued robust economic growth, strong central government finances, and an exceptionally strong external payments position;
2) Progress has been less than anticipated in the process of both reducing latent risks by making local government contingent liabilities more transparent and in reining in rapid credit growth; therefore, some of the upward pressure on the Aa3 rating has eased.
3) Credit-positive structural reforms under the new leadership are expected over time, but their scope and pace may not be sufficient over the course of the next 12-18 months to justify a rating upgrade; and
Moody’s has also affirmed China’s P-1 short-term foreign currency rating, as well as its Aa3 bond and deposit ceilings, which act as a cap on ratings that can be assigned to the domestic or foreign currency obligations of other entities domiciled in the country.
RATINGS RATIONALE
Firstly, underpinning China’s credit fundamentals is the country’s continued robust economic growth against a background of low inflation. Our central scenario is that China’s real GDP will grow 7.5-8.0% in 2013 and 2014. Beyond this period, Moody’s considers that urbanization and productivity gains will likely support growth in the 6-7% range through the rest of this decade.
But effective macro-prudential regulation of the financial system and the advancement of a broad range of reforms will likely be necessary to prevent the build-up of imbalances which could increase the risks of a hard landing for the economy.
Moody’s notes that China’s strong central government finances are reflected in small budget deficits of between 1% and 2% of GDP since the 2008 global financial crisis, moderate gross financing requirements of around 8% of GDP, and a debt burden of slightly less than 30% of GDP, and which is gradually declining.
Furthermore, China’s fiscal metrics are more favorable than those of other Aa-rated advanced countries, such as Belgium and France, with the exception of Korea, which has a broadly similar profile.
China’s external position remains exceptionally strong. Neither the government nor the banking sector relies on external funding, thereby reducing any vulnerability to global financial market disturbances.
The current account has narrowed sharply since the government’s adoption in 2005 of a renminbi appreciation policy, but remains in surplus. Most telling, China’s net international investment position was about 22% of GDP in the third quarter of 2012, meaning that its external assets were $1.8 trillion greater than its system-wide external liabilities according to the latest data. Only a handful of highly rated advanced industrial economies — such as Norway, Switzerland, Japan, Hong Kong and Singapore — have a stronger international investment position.
Secondly, the main constraints on further upward movement in the rating are associated with contingent liabilities, which could encumber the central government’s balance sheet and derail the transition to a more balanced and more moderately growing economy.
Although the National Audit Office originally identified RMB10.7 trillion in local level liabilities at end-2010 (about 27% of 2010 GDP)– of which RMB6.7 trillion were crystallized onto local government budgetary balance sheets — uncertainty lingers over whether these figures represent the full extent of the contingent risks arising from local government financing vehicles.
Additionally, the increased dependence of local government budgets on land sales introduces a considerable degree of vulnerability to volatility in the property market, and hence the health of their finances, and the possibility of a need for greater central government support.
Another risk facing China’s economy is the elevated growth in credit, and which has persisted even after the extraordinary surge in policy-induced bank lending in 2009. Credit growth is increasing driven by lending by the non-bank, shadow banking system.
While the total stock of shadow bank credit is currently not overly large and does not pose systemic risks, controlling such lending is beyond the scope of the People’s Bank of China’s policy instruments.
Therefore, macro-prudential regulations and the advancement of financial sector reform — such as interest rate liberalization the establishment of a transparent municipal bond market at the local government level — would help ensure that this shadow system does not destabilize the financial system in the future.
Thirdly, reform initiatives are taking shape under the new, fifth generation of leadership selected by the Chinese Communist Party last November and which took charge of governmental posts in March 2013.
The State Council announced an ambitious and wide-ranging strategy in February in its 35-point guideline on income distribution. The strategy covers a range of initiatives affecting the labor market, the state enterprise sector, financial markets, tax regime and legal system, along with initiatives to rein in corruption.
However, these guidelines lack specific detail, and there is no clear indication when such measures will be implemented and when they would gain traction in producing systemic changes.
CREDIT TRIGGERS FOR FUTURE RATING ACTIONS
Over time, a positive action could be prompted by the following factors: advancement of structural reform by China’s new leadership; further evidence that the moderation in economic growth is sustainable over the long term; financial sector stability, as evidenced by a more moderate pace of system-wide credit expansion; and greater transparency and certainty that off-balance sheet contingent liabilities at the local government level will not materially encumber the very strong financial strength of the central government
Conversely, downward pressure on the rating could arise from a significantly greater-than-anticipated slowdown in economic growth, deterioration in government finances from a material crystallization of contingent liabilities, or from a rise in social unrest which distracts the authorities from the conduct of sound economic and financial policies.
PREVIOUS RATING ACTION & METHODOLOGY
The last rating action on the People’s Republic of China was taken on 10 November 2010, when Moody’s raised China’s government’s long-term ratings to Aa3 from A1 and assigned a positive outlook.
The principal methodology used in this rating was Sovereign Bond Ratings published in September 2008. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.
REGULATORY DISCLOSURES
For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody’s rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider’s credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody’s legal entity that has issued the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.
Thomas J Byrne
Senior Vice President
Sovereign Risk Group
Moody’s Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (65) 6398-8308Bart Jan Sebastian Oosterveld
MD – Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 212-553-0376 begin_of_the_skype_highlighting212-553-0376 FREE end_of_the_skype_highlighting
SUBSCRIBERS: 212-553-1653 begin_of_the_skype_highlightingReleasing Office:
Moody’s Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (65) 6398-8308
Sources:
- China local authority debt ‘out of control’ (Simon Rabinovitch, Financial Times, 16 April 2013)
- Fitch Teleconf: China’s Sovereign Ratings (Fitch Ratings press release, 09 April 2013)
- Fitch downgrades China’s credit rating (Josh Noble and Simon Rabinovitch, Financial Times, 09 April 2013)
