China's Markets Get a Double Dose of Caution From Moody's, MSCIBy and
Moody’s sees leverage building thanks to growth fixation
MSCI concerned by trading suspensions, regulator control
For all the verbiage from Chinese officials on the need to rein in leverage and open markets to global investors, the nation’s leadership got a double dose of caution on Wednesday.
Moody’s Investors Service unveiled a surprise downgrade of China’s sovereign credit rating, citing concerns about its continued buildup of debt. Earlier, the head of one of the world’s top stock-index compilers suggested China had more work to do to get its onshore stocks into emerging-market gauges. With a June 20 deadline looming, “there’s still a lot of issues to resolve,” MSCI Inc. Chief Executive Officer Henry Fernandez said.
Underlying the critique from both: issues stemming from the Chinese leadership’s preoccupation with control. Few analysts expect painful reforms to be unleashed ahead of the Communist Party’s leadership reshuffle due later this year. While officials preach the need to rein in credit, ensuring the economy hits a 6.5 percent growth target remains the top priority.
Moody’s highlighted that policy makers’ are fixated on economic growth targets, meaning already-high leverage will continue to build. For MSCI, concerns include authorities placing restrictions on financial products abroad that would incorporate Chinese stocks.
“Today’s downgrade is yet another sign of the challenges faced by China,” said Luc Froehlich, Head of Investment Directing, Asian Fixed Income, Fidelity International.
The broader takeaway: while the country isn’t likely to face an outright financial crisis given the still-solid expansion rate, it remains some distance from winning a place on the global financial stage commensurate with its status as the world’s No. 2 economy. But there’s a silver lining: with capital controls in place and markets still somewhat walled off, authorities enjoy the freedom of not having to rely on foreign funding -- unlike their counterparts in places like Brazil.
MSCI, which has three times rejected including Chinese onshore stocks in its indexes, is due to unveil its latest decision on June 20. Fernandez outlined a number of continuing concerns, with time running out -- read about that here.
Moody’s said one reason why it anticipates leverage will continue to climb is “because economic activity is largely financed by debt in the absence of a sizeable equity market and sufficiently large surpluses in the corporate and government sectors.” China’s total debt burden is 258 percent of gross domestic product, the latest Bloomberg Intelligence estimate shows.
“The combination of slower growth and higher debt poses some contingent liabilities for the government,” Marie Diron, an associate managing director at the sovereign risk group at Moody’s, told Bloomberg Television.
President Xi Jinping’s ultimate goal is to raise China’s international profile across the board -- as a champion of globalization and a financier of development along old Silk Road routes across Eurasia. Another element has been winning reserve-currency status for the yuan, and authorities have increasingly opened up the bond market to outside investment as part of that initiative.
Yet the yuan’s share of global payments via the SWIFT system slumped to 1.8 percent as of March 31 from as high as 2.8 percent in August 2015. One measure of global central banks’ share of reserves held in yuan came in at 1.1 percent at the end of 2016. Another rejection by MSCI on A-share inclusion this year would serve as a reminder that China’s ambitions have some ways to be fulfilled.
The sovereign downgrade comes at a bad time as China seeks to open its bond market to foreign investors by making it easier to invest in its domestic market through Hong Kong. It will likely make it harder to lure foreign capital, especially given the slow pace of structural reforms, according to Bloomberg Intelligence Economist Tom Orlik.
“Progress remains faltering and in some respects movement is in the wrong direction,” said Orlik. “The inefficient state sector is expanding as a share of GDP. Economy-wide leverage continues to increase, with credit growth outpacing GDP by a significant margin.”
To be sure, China’s reliance on foreign funding isn’t large -- external debt is around 12 percent of GDP according to the International Monetary Fund. And foreign ownership of Chinese bonds is low, standing at around 3 percent compared with an average of up to 30 percent for other emerging markets, according to Investec Asset Management.
Still, the Moody’s move highlights China need to implement painful reforms to put its economy on a more sustainable footing. While authorities have promised to rein in financial risks, cheap credit continues to gush through the economy. And there are pockets of the bond market with foreign exposure, such as the latest rush of dollar debt from property developers.
For foreign investors, the balancing act between implementing reforms and ensuring growth targets are met means a continuing air of unpredictability, said Hao Hong, Hong Kong-based chief strategist at Bocom International Holdings Co.
“The domestic Chinese market works differently from the global markets that foreign investors are accustomed to,” he said.
— With assistance by Jeff Black