S&P downgrades China citing build up of debt

S&P Global Ratings downgraded China’s long-term sovereign credit rating on Thursday, less than a month ahead of one of the state’s most sensitive political gatherings, citing increasing risks from its rapid build-up of debt.

S&P’s one-notch downgrade to A+ from AA- comes as Beijing grapples with the challenges of containing financial risks stemming from years of credit-fuelled stimulus to meet ambitious government economic growth targets.

“The downgrade reflects our assessment that a prolonged period of strong credit growth has increased China’s economic and financial risks,” S&P said in a statement, adding that the ratings outlook was stable.

S&P had said in June there was a “real” chance of a downgrade and a decision would be made based on whether China is able to move away from a credit-driven growth strategy. The demotion follows a similar move by Moody’s Investors Service in May.

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While S&P's move put its China ratings on par with those of Moody's and Fitch, the timing raised eyebrows just weeks ahead of a twice-a-decade Communist Party Congress (CPC), which will see a key leadership reshuffle and the setting of policy priorities for the next five years.

“The downgrade is a timely reminder for the authorities that China needs to bite the bullet on some of the more painful reforms that have been left to last, namely corporate deleveraging and restructuring of state-owned companies,” said Rob Subbaraman, an economist at Nomura in Singapore.

“The focus needs to shift from quantity to quality of growth. I hope that later this year China lowers its GDP growth target to 6 per cent to 6.5 per cent, or not have one at all. That would be a positive sign.”

The International Monetary Fund warned this year that China's credit growth was on a "dangerous trajectory" and called for "decisive action", while the Bank for International Settlements said last September that excessive credit growth was signalling a banking crisis in the next three years.

The IMF said in August it expected China’s total non-financial sector debt to rise to almost 300 per cent by 2022, up from 242 per cent last year.

While worries about China’s sustained strong credit growth are increasing in some quarters, first-half economic growth of 6.9 per cent beat expectations and some analysts said the downgrade would have little impact on financial markets.

“The decision was a catch-up with the other two credit agencies, instead of an initiative. Its impact on financial markets would very limited,” said Ken Cheung, senior Asian FX strategist at Mizuho Bank in Hong Kong.

“For those invested in yuan-denominated bonds, they care more about yuan expectations. The downgrade decision is likely to have limited impact on capital inflows as well.”

China’s stock markets had closed Thursday before the downgrade, and there was little reaction in the yuan currency.

While risks are rising, S&P said the government’s recent efforts to reduce corporate leverage could stabilise conditions in the medium term.

“However, we foresee that credit growth in the next two to three years will remain at levels that will increase financial risks gradually,” S&P said.

S&P also lowered China’s short-term rating to A-1 from A-1+.

“It is in recognition of the reality that, concerns notwithstanding, the authorities are not planning to rein in credit growth in a forceful way,” said Louis Kuijs at Oxford Economics in Hong Kong.

-Reuters