This morning we have received news about the world’s second largest economy. The Ratings Agency Moodys issued this statement.
Moodys Investors Service has today downgraded China’s long-term local currency and foreign currency issuer ratings to A1 from Aa3 and changed the outlook from negative to stable.
As you can see from the statement this was not a complete surprise as the outlook had been negative although in some ways the timing was as not so long ago the IMF had told us this. From Reuters on the 18th of April.
The IMF upgraded its estimate for China’s 2017 growth to 6.6 percent from 6.5 percent, which it made in January. It also raised its forecast for growth next year to 6.2 percent from the previous 6.0 percent.
This added to the upgrade it has given China in January when it had raised the economic growth forecast for 2017 from 6.2%. In fact only on the 9th if this month the IMF had repeated this message.
In China, the region’s biggest and the world’s second largest economy, policy stimulus is expected to keep supporting demand. Although still robust with 2017 first quarter growth slightly stronger than expected, growth is projected to decelerate to 6.6 percent in 2017 and 6.2 in 2018.
This slowdown is predicated on a cooling housing market, partly reflecting recent tightening measures, weaker wage and consumption growth, and a stable fiscal deficit.
Although whilst it was relatively upbeat the IMF has warned about credit expansion.
Why did Moodys act?
As the quote from the Financial Times below shows Moodys are concerned about the financial system in China.
“The downgrade reflects Moody’s expectation that China’s financial strength will erode somewhat over the coming years, with economy-wide debt continuing to rise as potential growth slows,” Marie Diron, the agency’s associate managing director for sovereign risk, wrote in an announcement on Wednesday.
Indeed if we look at the statement they expect China to go along at least part of the journey that us westerners have travelled.
While China’s GDP will remain very large, and growth will remain high compared to other sovereigns, potential growth is likely to fall in the coming years. The importance the Chinese authorities attach to growth suggests that the corresponding fall in official growth targets is likely to be more gradual, rendering the economy increasingly reliant on policy stimulus.
Of course their economic growth is officially recorded at higher levels than ours but it looks like the Chinese will have to accept a sort of new normal where economic growth is lower just like we have.
GDP growth has decelerated in recent years from a peak of 10.6% in 2010 to 6.7% in 2016.
If we look at the situation in terms of the national debt to GDP ratio we have looked at for Greece and the UK this week already then it looks as if China is currently in a lot better place.
Moody’s expects China’s direct fiscal debt to reach 40 per cent of gross domestic product by the end of next year and 45 per cent by 2020. ( Financial Times).
However in a development which is very familiar just like us Westerners the Chinese do all they can to keep what is public-sector debt off the official books.
In addition, it notes that China’s reliance on disguised fiscal spending through off-budget special purpose vehicles owned by local governments is likely to persist. The Financial Times reported this month on a confidential World Bank assessment warning of risks from so-called local government financing vehicles.
Moodys are expecting further growth in this area.
Similar increases in financing and spending by the broader public sector are likely to continue in the next few years in order to maintain GDP growth around the official targets.
Let us look at the wider debt burden in China which is something I looked at back on January 5th.
China’s total debt load had reached 255 per cent of GDP by the end of June, up from 141 per cent in 2008 and well above the average of 188 per cent for emerging markets, according to the Bank for International Settlements.
Moodys thinks that this will happen going forwards.
More broadly, we forecast that economy-wide debt of the government, households and non-financial corporates will continue to rise, from 256% of GDP at the end of last year according to the Institute of International Finance. This is consistent with the gradual approach to deleveraging being taken by the Chinese authorities and will happen because economic activity is largely financed by debt in the absence of a sizeable equity market and sufficiently large surpluses in the corporate and government sectors.
I would counsel caution about the use of averages here as not only can they be misleading without an idea of dispersion it could be signalling a group going over the cliff together.
Debt and Demographics
Should debt continue to rise then China will share a problem that is affecting more than a few of the evil western capitalist imperialists. From my article on January 5th.
“In 10 to 15 years, China’s demographic decline will become more prominent, and the labour force will be declining by about 5m people per year,” says Brian Jackson, senior economist at the Beijing office of IHS, a consultancy.
Mining.com updates us on the trends for Iron Ore.
The Northern China import price for 62% Fe iron ore fines was $61.90 a tonne on Monday, down more than 20% year-to-date on growing fears of an oversupplied market.
There is quite a bit going on as the Chinese increasingly use scrap iron in production but it is hard not to think of the Iron Ore which was used as collateral in financial deals as we looked at some time back.How much of that is in today’s 5% fall in the price of Iron Ore futures is hard to say. Dr.Copper rallied at the end of 2016 after several years of decline but seems to have mostly flat lined in 2017 at around US $2.50.
This month’s business surveys recorded something of a slow down.
The Caixin China Composite PMI™ data (which covers both manufacturing and services) signalled a further slowdown in growth momentum at the start of the second quarter. This was highlighted by the Composite Output Index posting 51.2 in April, down from 52.1 in March, and the lowest reading for ten months.
The ratio between the numbers here and official levels of economic growth are very different to what we see in the west but any slow down will not be welcome.
There are a few things to consider here. Firstly we are unlikely to see much of a fall in bond prices and rises in yields in response to this as used to happen. The Chinese bond market is almost entirely ( ~ 96% ) domestically owned making it rather like Japan meaning that any selling by foreign investors is not that likely to be significant. Also these days central banks mostly intervene to stop such things don’t they?
Moving onto the economy we see that monetary conditions are the issue and for this to end well the Chinese will have to make a much better job of dealing with a credit boom than we did in the west. Will they be able to continue to tighten policy if economic growth slows further? As to outflows of money we are regularly assured these days that they have pretty much stopped but to my mind there is a worrying signal which is the continuing rise in the price of bitcoin.
The average price of Bitcoin across all exchanges is 2326.72 USD ( @bitcoinprice )
Finally these things are not the same without an official denial are they? From Xinhua News.
China’s Finance Ministry on Wednesday dismissed a decision by international rating agency Moody’s to downgrade China’s long-term local currency and foreign currency issuer ratings.