Is China’s downgrading a cause for concern?

Is China’s downgrading a cause for concern?

China, financial risks, ANZ, strong credit growth

China’s credit rating has been downgraded by a major ratings agency due to the financial risks that accompanied the country’s prolonged “strong credit growth”.

According to ANZ, however, the news may not be as dire as it seems.

S&P ratings last week downgraded China’s long-term credit ratings from AA- to A+ with a stable outlook.

 

At the time, S&P said: “The downgrade reflects our assessment that a prolonged period of strong credit growth has increased China's economic and financial risks.

It also flagged a lack of transparency around policy intent as leading to a potential “misallocation of resources” while fostering “discontent over time”.

The move follows a similar downgrade by Moody’s in May and falls less than a month before China’s five-year National Congress, the most important political event in China’s calendar.

While the Chinese government has labelled the downgrade “mistaken” and “perplexing”, ANZ economists have said there’s not so much to worry about from a global financial perspective.

ANZ's head of Asia research, Khoon Goh and chief economist for Greater China, Raymond Yeung said in an ANZ note: “Our observation is that China’s debt situation has actually improved, thanks to the recent unprecedented deleveraging effort.

“Our analysis shows that if China can maintain its recent pace of deleveraging, the debt-to-GDP ratio could peak at 273 per cent by 2020 (June 2017: 255 per cent) before a gradual decline thereafter.

They continued: “In fact, there has been a growing consensus in the economic literature that positive credit growth is not an issue but the key is whether such growth will reach a steady state. The debt dynamics in China are not as bad as commonly perceived.”

However, the economists conceded that the downgrades will “serve as a reminder for policymakers” to pursue reforms and mitigate the risk of “falling into a deflationary trap”.

As for effects on the financial market, the economists predict it to be “limited”, noting that the country’s domestic bond market has been “largely onshore-driven” while foreign demand for Chinese bonds still remains strong.

They also pointed to the fact that following the Moody’s downgrade, China 10-year bond yields remained largely stable and the yuan has also strengthened since then.

“We do not expect the S&P downgrade to change the appetite for China bonds.

“China’s A+ rating is now similar to Japan’s, but offers the highest yield among not only the special drawing rights currencies [a type of monetary reserve currency that was created by the International Monetary Fund to function as a supplement to existing reserves of member states], but also the most commonly held currencies by reserve managers.

“We expect the renminbi [Chinese currency] to remain stable on a basket basis, with USD/CNY [Chinese yuan] to be driven more by broad dollar moves,” they concluded.

Is China’s downgrading a cause for concern?
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