Fitch Cuts China Yuan Debt Rating on Local Government

Fitch Ratings Ltd. cut China’s long-term local-currency debt rating, citing rising risks to the country’s financial stability given the lack of transparency in the increased borrowing of local governments.

Fitch lowered its assessment by one step to A+, the fifth-highest grade, the London-based company said in an e-mailed statement yesterday. It estimates total credit in China’s economy, including various forms of so-called shadow banking, may have reached 198 percent of gross domestic product at the end of 2012, up from 125 percent four years earlier.

The ratio of credit to GDP “is not stabilizing anytime soon,” Charlene Chu, Beijing-based head of China financial institutions at Fitch, said in a teleconference today. “We are getting increasingly worried about the fact that we could have an asset-quality problem in the financial sector. One sector of borrowers that we are concerned with is the local governments.”

The local governments may have had 12.85 trillion yuan ($2.1 trillion) in debt at the end of last year, equal to about 25 percent of GDP, up from 23.4 percent at end-2011, Fitch said. Former Finance Minister Xiang Huaicheng said April 6 that their combined debt may have exceeded 20 trillion yuan, almost double the figure given in a 2011 report by the National Audit Office.

‘Opaque’ Lending

Chinese local governments “likely have significant additional contingent liabilities” arising from the debts of companies linked to them, Fitch said. The ratings company said lending between such entities and business had been “opaque.”

Fitch affirmed China’s long-term foreign-currency debt rating at A+ and said the outlook is stable. Local-currency ratings apply to both domestic debt and offshore yuan-denominated notes, the company said.

An upgrade is unlikely over the next couple of years because chances are the credit expansion won’t unwind in that period, Andrew Colquhoun, head of Asia-Pacific sovereigns at Fitch in Hong Kong, said on the teleconference.

The total borrowings of China’s central government and the nation’s provinces and cities may have exceeded 30 trillion yuan, Xiang, who served as finance minister from 1998 to 2003, said at the Boao Forum for Asia. Local governments had 10.7 trillion yuan of debt at the end of 2010, the auditor said in its report.

Subprime Similarities

Billionaire investor George Soros said China has a “couple of years” to control risks from non-traditional financing, whose expansion has parallels with the cause of the global financial crisis. The growth of shadow banking has “some disturbing similarities with the subprime-mortgage market in the U.S.,” Soros said in a speech at the Boao Forum on April 8, adding the authorities “have both the skills and the resources to deflate an incipient bubble gradually.”

Aggregate financing, an indicator started by the central bank in 2011 to provide a broader gauge of funding than bank loans, more than doubled from a year earlier to a record 2.53 trillion yuan in January. The measure, which includes all loans as well as the proceeds of bond and equity sales, was 1.07 trillion yuan in February and data in the coming week is forecast to show financing totaled 1.80 trillion yuan in March, based on the median estimate in a Bloomberg survey.

‘Alarmingly High’

“More attention should be paid to the pace of credit expansion through other channels, which is already alarmingly high,” Wang Qinwei, an economist at Capital Economics, wrote in a note today. “This concern was reflected in Tuesday’s move by Fitch to downgrade China’s long-term local-currency rating by one notch to A+.”

Bond-market history indicates that the effect of sovereign ratings may be limited. Almost half the time, yields on government bonds fall when a rating action by S&P and Moody’s Investors Service suggests they should climb, according to data compiled by Bloomberg on 314 upgrades, downgrades and outlook changes going back as far as the 1970s.

After S&P stripped France and the U.S. of AAA grades, interest rates paid by the countries to finance their deficits dropped rather than rose.

China’s 10-year sovereign bond yield fell to 3.47 percent yesterday from this year’s high of 3.61 percent on Jan. 29. Top-rated corporate debt with similar maturities pays 5.11 percent, 18 basis points less than at the start of the year.

In Hong Kong’s offshore market, the yield on China’s government Dim Sum bonds due June 2022 was steady at 2.94 percent today, according to data compiled by Bloomberg. The rate has fallen 50 basis points, or 0.50 percentage point, from a record 3.44 percent reached on Sept. 17.

Limited Impact

The rating downgrade won’t have much market impact, according to Credit Agricole CIB and Societe Generale SA.

“The issues discussed by Fitch are not new and what is more important is that we are seeing positive action from the newly formed government to address such matters, for example the control over wealth management products,” Wee-Khoon Chong, a Societe Generale strategist in Hong Kong, wrote in a note yesterday. The downgrade should not have “a meaningful market impact” on China’s bonds or the yuan, Dariusz Kowalczyk, a Credit Agricole strategist in Hong Kong, said today.

Stronger Yuan

The yuan touched a 19-year high today of 6.1933 per dollar in Shanghai. It held gains even after government data showed the trade balance swung to an unexpected deficit of $880 million in March from a $15.2 billion surplus the previous month. Economists forecast a $15.15 billion surplus, based on the median estimate in a Bloomberg survey.

The cost of insuring China’s government bonds against non-payment for five years fell two basis points to 72 yesterday in New York, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. The credit-default swap touched 75 on April 1, the highest since October.

China’s banking regulator last month told lenders to limit investments of client funds in debt that isn’t publicly traded and to isolate such risks from their operations. Such investments can’t exceed 35 percent of all funds raised from the sale of wealth management products, or 4 percent of the lender’s total assets at the end of the previous year, the China Banking Regulatory Commission said.

“It’s too early at this point to see how strict the authorities are going to be with implementation and how innovative Chinese banks are going to be in terms of possibly getting around some of those regulations,” said Fitch’s Chu.

— With assistance by Alexandra Ho, and Fion Li

Before it's here, it's on the Bloomberg Terminal.