Credit rating agency Standard and Poor’s has revised their outlook for China’s sovereign credit rating to negative from stable because it believes the country’s “economic rebalancing is likely to proceed more slowly than we had expected”.
Standard and Poors left China’s AA- long-term and A-1+ short-term sovereign credit ratings at current levels but warned it had “revised the outlook to reflect our expectation that the economic and financial risks to the Chinese government’s creditworthiness are gradually increasing.”
That’s not to say Standard and Poor’s thinks the economy is about to tank. Rather they say their rating outlook change is based on an expectation that “China’s economic growth over the next three years will remain at or above 6% annually”.
But the risk is in a deterioration to “government and corporate leverage ratios” as China tries to keep its growth elevated the company said. That’s because the “investment rate could be well above what we believe to be sustainable levels of 30%-35% of GDP and among the highest ratios of rated sovereigns”.
That means China’s “resilience to shocks, limit the government’s policy options, and increase the likelihood of a sharper decline in trend growth rate”.
Overall Standard and Poor’s is still positive on growth longer term.
“By 2019, we project per capita GDP to rise to more than US$10,000 from a projected US$8,200 for 2016, given our assumptions about growth and the relative strength of the renminbi versus the dollar. Over the next three years, we expect final consumption’s contribution to economic growth to increase,” the company said in its ratings report.
But the risk remains that China’s debt burden will continue to grow from “below 165% of GDP in 2016 to close to 180% by 2019,” the company said.
That’s a risk to the rating and growth.
But in contrast to hedge fund bets, and many traders who believe China is just a weak economic print away from massive capital flight and a Yuan devaluation, Standard and Poor’s said the country’s external profile remains a strength “despite the decline of China’s foreign exchange reserves”.
They say that “the fall of reserves to increased expectations of renminbi depreciation. This reflected the uncertainties following a change in the authorities’ management of the currency introduced last year. As a consequence, some private sector firms reduced or hedged their dollar debt and exporters kept a greater share of their proceeds in foreign exchange. This source of financial account outflows should dissipate as expectations adjust with clearer policy signals regarding the exchange rate policy”.
That implies that the company believes recent proclamations by authorities that the Yuan can remain stable.
Indeed Standard and Poors said that foreigners will continue to buy the Yuan to hold as reserves but the company also showed just why so many traders and hedge funds think the Yuan needs a substantial devaluation (our emphasis):
Over time, we expect the share of renminbi-denominated official reserves to rise to its share of foreign exchange transactions. Although the People’s Bank of China (the central bank) does not operate a fully floating foreign exchange regime, over the past decade it has allowed greater flexibility in the nominal exchange rate. Based on estimates from the BIS, we compute that the real effective exchange rate has also appreciated by close to 21% since 2011.
But for all of the apparent positives Stnadard and Poor’s cites, it still says that China’s “negative outlook reflects our view of gradually increasing economic and financial risks to the government’s creditworthiness, which could result in a downgrade this year or next”.