China downgrade predicted by Euromoney survey

Feeling the heat: but the downgrade doesn't necessarily mean China is an imminent major risk

Moody’s downgraded China from Aa3 to A1 on Wednesday, after previously altering the rating from positive to negative in March 2016.

That doesn’t mean China is an imminent major risk.

As Euromoney indicated at the time: “Talk of a crisis is overblown, but the world’s most populous nation is still struggling to convince the experts, as its risk score declines.”

Soon after, Amy Zhuang at Nordea Research stated: “We expect the government stimulus to successfully prevent an economic crisis this year, but the explosive credit expansion adds to the medium-term risk of a burst of the large debt bubble.”

Indeed, China has failed to provide a convincing investor case ever since the global financial crisis. If anything, the nagging doubts about its imbalances have intensified.

China has slipped two places in the survey since ECR made the case for a downgrade, and is now 43rd out of 186 countries surveyed in the global rankings.

That makes it a tier-three sovereign, which is broadly equivalent to a BB+ to A- credit.

On that basis, Moody’s downgrade is not just overdue but the new rating is still higher than qualified by its risk metrics.

Weakened

Since Euromoney issued its warning in March 2016, China’s bank stability score has weakened further to just five out of 10. Its score for transparency is lower, and its capital access score is reduced.

What does it all mean?

According to Moody’s: “China's financial strength will erode somewhat over the coming years, with economy-wide debt continuing to rise as potential growth slows.”

Alicia Garcia Herrero and Gary Ng at Natixis have rush-released a briefing, detailing the implications.

In it they state: “The impact on China’s domestic markets will be limited, except for further discouraging foreign investors into the market.

“However, we do expect higher funding cost in the offshore market, especially for higher leveraged corporates. We also expect more reaction for smaller banks exposed to the offshore market than the larger ones.”

ABN Amro senior economist Arjen van Dijkhuizen reported last week “the markets have turned nervous again over China”, noting falling metals prices and an under-performing stock market, which relate to the targeted policy tightening having an impact on economic growth.

With China’s risk score still languishing, it might not be long before Standard & Poor’s follows suit, as it also attaches a negative assessment to its AA- rating. Watch this space.