Ratings Understate `Dangerous' Chinese Local Government Risks, Dagong Says
Guan Jianzhong, chairman of Dagong Global Credit Rating, poses for a portrait at the company's office in Beijing. Photographer: Nelson Ching/Bloomberg
Credit ratings assigned to yuan- denominated bonds issued on behalf of local governments in China are misleading and don’t reflect risks investors face, Dagong Global Credit Rating Co.’s chairman said.
Local government-backed borrowers shop around for the best rankings from Chinese ratings companies and “whoever gives them a better rating gets the business,” Guan Jianzhong, chairman of privately owned Dagong, one of China’s five official ratings agencies, said in a Bloomberg Television interview in Beijing yesterday. “This is very dangerous.”
Guan’s comments show growing concern at credit risks stemming from a record borrowing binge spurred by China’s efforts to revive economic growth during the global recession. Chinese banks may struggle to recoup about 23 percent of the 7.7 trillion yuan ($1.1 trillion) lent to finance local infrastructure projects, according to a person with knowledge of data collected by the China Banking Regulatory Commission.
“It reflects the lack of transparency in local-government finance,” Tom Orlik, a Beijing-based China economist at Stone & McCarthy Research Associates, said in a telephone interview. “It’s very difficult to get an accurate gauge of the repayment capacity either of the local government financing vehicles or of the local governments themselves.”
Standard & Poor’s, Moody’s Investors Service and Fitch Ratings drew criticism in the U.S. from investors and officials including Financial Crisis Inquiry Chairman Phil Angelides for assigning top rankings to mortgage-linked securities that crashed when the U.S. housing market collapsed in 2007.
No Junk
“In China most companies can’t issue junk bonds, they have to be at least AA to apply for debt issuance,” Guan said. Local governments set up financing vehicles to fund projects such as highways and airports with bonds and loans, due to limits on their ability to directly borrow money.
According to China Lianhe Credit Rating Co., 43 urban construction companies affiliated with municipalities, provincial and prefecture-level cities, as well as counties, issued bonds totaling 59.2 billion yuan ($8.7 billion) in the first half of 2010. Of the 72 corporate bonds sold in the first half, 70 were rated AA or above, Lianhe said.
China has more than 1,000 county-level governments and hundreds of city and municipal councils that get revenue from local taxes, land sales and central-government transfers. Premier Wen Jiabao’s crackdown to prevent a real-estate bubble has left cities such as Tianjin, southeast of Beijing, reeling as revenues slump from land sales, which made up 41 percent of income in 2009.
Danger Signals
“If you look at the financial crisis, it was caused by an accumulation of credit risks,” said Guan. “When it gets to a certain point, then a crisis breaks out.”
China this year restricted borrowing on concern money isn’t being used for viable projects. While Dagong expects defaults on bank loans used to fund infrastructure construction, there won’t be a risk to the banking system as regulation has improved, he said.
Financing vehicles linked to local governments issue bonds in China’s exchange-traded and interbank markets. These notes are bought by asset managers, securities firms and other institutional investors. Commercial banks are restricted to buying in the interbank market.
Beijing-based Dagong gave China’s government a higher debt rating than the U.S., U.K. or Japan in a report covering 50 nations it published this month.
Two other big ratings companies in China are tie-ups with international partners. China Chengxin International Credit Rating Co. is a joint venture with Moody’s Corp., and China Lianhe Credit Rating is a joint venture partner with Fitch Ratings Ltd. Foreign ratings firms aren’t allowed to directly rate Chinese domestic currency bonds.
Dagong has applied to the Securities and Exchange Commission to start ratings coverage in the U.S. The firm expects a final SEC decision in September.
--Henry Sanderson, with assistance from Stephen Engle in Beijing. Editors: Hugh Chow, Tom Kohn
To contact Bloomberg News staff on this story: Henry Sanderson in Beijing at 86-10-6649-7548 or hsanderson@bloomberg.net
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