On May 24, 2017, Moody’s Investors Service downgraded the credit rating of China due to the country’s slow growth and increasing debt.
In technical terms, the move is akin to reducing the rating of the long-standing currency issuer of China from Aa3 to A1. This means higher costs of borrowing for Chinese state-owned companies, government institutions, and the China government itself.
The last sovereign rating cut of China by Moody’s occurred in 1989 when the extremely violent response of the government to the protests at Tiananmen Square resulted in stunting of the economic momentum in the country.
The downgrade was criticized by the Chinese government. As per Xinhua, the state news agency of the country, the government called the move as being ‘inappropriate.’ The Finance Ministry of China stated that the viewpoints of Moody’s slightly underestimate Chinese capabilities to better structural supply-side reform and slightly overestimate problems faced by the economy of the country.
Moody’s however upgraded its outlook for China from negative to stable. The firm stated that the ratings downgrade is reflective of the expectation by them that the financial prowess of China will slightly erode in the following few years as the debt across the economy continuously rises while there is simultaneous slowdown of potential progress and growth.
The Chinese government persists with increased emphasis on exports to maintain high growth. This is despite the fact that the domestic economy is booming. The exports policy has resulted in sustained burrowing by enterprises owned by the state as well as stimulus packages. All of the country’s debt which includes debt owned by households, government, and non-financial enterprises, has ballooned to over 250 percent of China’s GDP. This has led to the situation being compared to the state in the US before 2008’s financial crisis.
Moody’s clarified that such levels of debt are quite common in countries with high ratings. However, such debt is often observed in nations with financial markets, per capita incomes, and institutions that are respectively deeper, higher, and stronger than China’s.
It may however be noted that Moody’s China outlook change to stable is a sign of its evaluation that decline of credit profile of China will tend to be gradual over some years and will ultimately be restricted due to deepening of reforms.
The growth rate of China may be higher that a lot of developed countries; but from its peak of 10.6 percent in 2010, it has currently slowed down and sunk to 6.7 percent in 2016. Moody’s stated that continued robust manufacturing and growing exports will ensure that the GDP of the China will continue growing and will most likely remain strong.
Some of the measures that China needs to take for reform and ease the pressure include encouragement of entrepreneurship and private investment, reduction of excess capacities at factories owned by the state, and advancement of domestic consumption.
Moody’s stated that the current improvement on reforms may lead to financial system and economic transformation over some period of time, but it will probably be insufficient in preventing additional material increase in widespread economic debt and consequently the government’s contingent liabilities will also rise.
Due to maturing of the country’s economy and the distinctive challenges that it is currently facing, Moody’s expects the growth potential of China to reduce to nearly 5 percent over the course of the next 5 years.
Slowdown in the economy will eventually lead to decline in local and foreign investments in companies. The fall in working-age people started in 2014 and this will continue and hasten in following years. There are ongoing corporate expansions, higher skill levels, and additional foreign investments in China. However, productivity may continue to be a cause of concern.
S&P Global Ratings did not change its negative outlook on China due to the mounting debt of the country. It however stated that a downgrade in credit ratings may be considered by them in the near future. As per a report by S&P, the negative outlook to China is reflective of their assessment about slowly rising financial and economic risks to the creditworthiness of the government, which may lead to a ratings downgrade by them in 2017 or 2018.
Does India benefit from China’s rating downgrade by Moody’s?
The current rating of China, despite the downgrade by Moody’s, is still one of the highest. Hence, India will most likely not get an edge over China after the ratings change. However, downgrade of sovereign credit rating indicates to the world that all is not hunky dory in the country, particularly when it is preparing to launch its grand one-belt one-road program aimed at dominating the planet.
India is way behind communist China in many different sectors. But India has also made increasing gains in technology, FDIs/Foreign direct investments, and manufacturing. China is growing conscious of this fact and is becoming wary of India’s growth.
Foreign exchange reserves of China are diminishing, while India is aggressively advertising itself as the best place for foreign investment. Chinese President Xi Jinping had recently stated that he would completely throw open the doors of China to all investors and businesses. There were also announcements by Premier Li Keqiang about similar treatment to domestic and foreign firms with regards to licensing, government procurement, and standardized settings.
For the first time in 2015, India became the leading nation on the planet for foreign direct investments by capital investment. Its $63 billon FDI helped India overtake the $59.6 billion FDI in the US and the $56.6 billion FDI in China. This has caused the Chinese officials to sit up and take notice.
China is also afraid that India will become the leader in manufacturing field over a period of time due to rising Chinese labor costs. Research has found that the 2016 hourly wage in manufacturing sector in China was nearly 5 times that in India. Another point of worry for China is the fact that exports by India to China increased by 42 percent in January 2017. China is still very superior to India when it comes to bilateral trade. But China is keeping an eye on the bilateral trade scene to verify whether the increase was a one-time thing or some sort of trend.
Moody’s downgrade of China may only be of symbolic importance to India. China’s economy is several times bigger than India and hence India cannot be currently regarded as an economic rival. However, India does certainly gain an edge due to the decline in international sentiment about the economy of China.