China and Ratings Agencies’ Double Standards
In May 2017, Moody’s Investor Service downgraded China’s credit rating. In September, Standard & Poor’s, too, cut China’s credit rating, citing the risks from soaring debt.
Interestingly, S&P revised China’s outlook to stable from negative, although rating cuts usually go hand in hand with more negative outlook.
Like major advanced economies, China has now a debt challenge. Yet, the context is different and so are the implications.
Drivers of China’s leverage
In 2008, at the eve of the global crisis, China’s leverage – as measured by a ratio of credit to GDP – was 132 percent of the economy. Even in 2012, it was still barely 160 percent. Yet, today, it amounts to 258 percent of the economy and continues to soar. In relative terms, that’s almost twice as high as in 2008. Why has Chinese debt risen so rapidly?
Historically, the increase can be attributed to two surges. The first was the result of the $585 billion stimulus package of 2009, which supported the new infrastructure but also unleashed a huge amount of liquidity for speculation. Today, the latter is reflected by China’s excessive local government debt (whereas central government debt remains moderate).
Another sharp surge followed in 2016, which saw a huge credit expansion as banks extended a record $1.8 trillion of loans. It was driven by robust mortgage growth, despite government measures to cool housing prices. As a result, credit was growing twice as fast as the growth rate.
China's leverage is likely to continue to rise to 288 percent of the economy by 2021. Nevertheless, the debt-taking is now slowing, which suggests that the central government's effort to deleverage corporates has started to bite – already before the 19th Party Congress.
However, there is a degree of double-standard in China’s rating cut. Ratings agencies punch emerging economies around, but treat advanced economies with silk gloves.
High debt but privileged ratings
When China’s leverage is reported internationally, it triggers much concern about the future. Indeed, that leverage (258% of GDP) is significantly higher than that of emerging economies overall (189% of GDP). But is the latter any longer an appropriate benchmark?
After all, most emerging nations are amid industrialization, but China is transitioning to a post-industrial society. That’s the goal of the rebalancing of the economy from investment and net exports to consumption and innovation, by around 2030.
Moreover, advanced economies’ leverage (268% of GDP) exceeds that of China. While the ratio of the US (251%) is close to that of the mainland, those of the UK (280%), Canada (296%) and France (299%) are significantly higher.
Yet, the credit ratings of these advanced economies – Canada (AAA), US (AA+), France (AA) and the UK (AA) – are substantially better than that of China (A+).
The ratings agencies appear to presume that the outlook of advanced economies is more stable than that of China. But is it?
Similar debt levels, different future prospects
In advanced economies, total debt has accrued in the past half a century; decades after industrialization. In these countries, the accrued debt is the result of high living standards that are no longer sustained by adequate growth and productivity. So leverage allows them to enjoy living standards that they can no longer afford to.
An even more interesting example is Japan in which leverage is one of the highest in the world (373% of GDP). While that rating is more than 100 percent higher than in China and continues to soar, thanks to record-low interest rates and massive monthly monetary injections, Japan’s current credit rating is A+; the same as China’s.
The context of leverage is very different in China, where excessive debt was accrued in only half a decade; not in the past half a century as in most advanced economies. Unlike the latter, different regions in China are still coping with different degrees of industrialization. Since the urbanization rate is around 56%, intensive urbanization will continue another decade or two, which will ensure solid growth prospects.
However, due to differences in economic development, Chinese living standards remain significantly lower relative to advanced economies. Nevertheless, they will double between 2010 and 2020, due to solid growth outlook and rising productivity.
In advanced economies, debt is a secular burden; in China, it is a cyclical side-effect. Yet, China has been penalized with a lower credit rating than advanced economies, which suffer from secular stagnation and have little hope to reduce their debt.
For years, Chinese policymakers have advocated tougher measures against leverage. In late 2016, People’s Bank of China adopted a tighter monetary stance, while tightening began last May. Still tougher measures are likely to follow after the Party’s 19th Congress.
Indeed, the central government efforts to rein in corporate leverage could stabilize the prospects of downside financial risks by the early 2020s. Yet, even then credit growth will remain at levels that increase financial stress over time. What is even more problematic is that, after the next half a decade, advanced economies will face a far greater leverage distress that they will find challenging to reduce.
That’s precisely when ratings agencies’ double standards will come back haunting them as secular stagnation will only continue to deepen in advanced economies.
Dr Dan Steinbock is the founder of Difference Group and has served as research director at the India, China and America Institute (USA) and visiting fellow at the Shanghai Institutes for International Studies (China) and the EU Center (Singapore). For more, see
The original commentary was released by South China Morning Post on October 22, 2017