It is hardly news that China has a huge and fast-growing debt pile, which explains investors' muted reaction to yesterday's mainland sovereign downgrade by Moody’s. Especially as local buyers, who own 96% of outstanding government bonds, tend to ignore foreign ratings.
But what may have particularly needled Beijing about the move is its timing. It comes just a week after the official approval of the Bond Connect scheme, and as the authorities push hard for onshore securities to be included in global indices and open up the renminbi debt markets.
The downgrade serves as an international warning to foreign investors, wrote Chi Lo, senior economist for greater China at BNP Paribas Investment Partners, in a statement.
“Probably, the immediate effect of the downgrade may be felt by the China-Hong Kong Bond Connect scheme, which is expected (not confirmed) to be launched in July this year in celebration of the 20th anniversary of Hong Kong’s reversion to China,” said Lo. “At a lower credit rating, it may be more expensive for the authorities to get the scheme off the ground or risk a launching delay.”
Tom Orlik, an economist at Bloomberg Intelligence, made a similar point, saying the downgrade came at a bad time for Beijing.
“China is moving aggressively to open its bond market,” he noted. “The aim is to increase the efficiency of credit allocation, and balance an exodus of domestic funds. A lower rating – with China now at the same level as high-debt Japan – will make it more expensive for Chinese authorities to do so.”
What's more, added Orlik, the move comes as index provider MSCI hints that significant hurdles remain to including China in its emerging-market equity benchmark.
“Moody’s analysis – which majors on limited deleveraging and reform – doesn’t come as a surprise,” he concluded. “Still, it adds to the sense of stalled momentum.”
Others were more sanguine about the potential impact on mainland bond market opening.
Barnaby Nelson, head of investors and intermediaries for Northeast Asia at Standard Chartered, did not think the downgrade would impact China bond's inclusion in global bond indices. "You have other countries in the emerging-market index that have lower ratings than China," he told AsianInvestor.
Morever, little has changed in respect of the mainland credit market, with foreign investors still sceptical about local corporate bond ratings.
Nelson said institutional investors' key concerns in terms of rating centre on Chinese corporate bonds. Ultimately, they don’t trust those credit ratings and worry that the bonds may default, he added.
The chief investment officer of Korea’s Public Officials Benefits Association (Poba), reinforced this point. Jang Dong-Hun told AsianInvestor on the sidelines of the Asian Investment Summit earlier this month that the state fund had no investment in China bonds.
Currency is one concern, Jang noted, while other factors include the fact that the financial system's reform is not complete and credit ratings for corporate bonds are not reliable in some cases.
Background to Moody's move
Moody’s said yesterday it was downgrading the country from Aa3 to A1 amid fears that China’s financial position would “erode somewhat over the coming years”. In particular, it pointed to rising leverage and the increasing chance that the Chinese governments focus on growth would lead it to keep filling the gap with fiscal stimulus, leading a rise in government debt.
The agency expects China’s direct fiscal debt to reach 40% of gross domestic product by the end of next year and 45% by 2020, in line with a median debt level of 41% in 2016 for A-rated sovereigns but above the 37% median for those with double-A ratings.
China’s Ministry of Finance responded to the move on Wednesday afternoon, saying the rating agency underestimated its ability to enact supply-side reforms and boost demands, and predicting no major change in government debt in the next four years.