WHAT CHINA´S DOWNGRADE SIGNALS TO INVESTORS / THE WALL STREET JOURNAL

What China’s Downgrade Signals to Investors

Most telling about S&P’s downgrade was that compared with peers, China had ‘less transparency, and a more restricted flow of information’

By Anjani Trivedi


CAN IT DO IT?
S&P estimate of China´s ratio of net government debt to GDP

A global rating agency has once again downgraded China, and there is little new information for investors to digest. It may however be worth reading between the lines.

Joining its ratings peers Fitch and Moody’s , Standard & Poor’s downgraded China’s sovereign rating by a notch for the first time in nearly two decades. Citing well known worries, the rating agency said China’s fast-accumulating debt load was raising financial and economic risks.

As with previous downgrades related to China, markets may shrug it off. S&P is, after all, saying what others have said about the economy’s reliance on debt. However, this downgrade comes at a particularly sensitive time. In a few weeks, China’s Communist Party will hold its 19th National Congress, in which President Xi Jinping is expected to consolidate power.

Officials and executives have been on high-alert mode in recent months, wary to rock the boat.

But most telling about the downgrade was S&P’s assertion that compared with its similarly rated peers, China had “less transparency, and a more restricted flow of information.”

DOWN THE STAIRS
S&P estimate of China´s GDP growth

The assertion is that China is less open than it was when it earned its last upgrade in 2010. In many ways, the once unstoppable China economic reform story, remains, if not in reverse, then at least showing little progress. It is a grim reality that should be taken seriously, especially as investors pin hopes on the coming party Congress to finally deliver market-friendly changes to the economy. Foreign investors have poured close to 300 billion yuan ($45 billion) into China’s stocks and bonds in the first six months of the year.

It is a curious side note, then, that in S&P’s assessment, one of the biggest concerns about China—the government’s contingent liabilities—isn’t a central point of worry. It now includes, by its estimate, $3.9 trillion of local government debt, plus that of state-owned China Railways, in its calculation. But contrary to Moody’s, which cited these rising contingent liabilities for its downgrade just months ago, S&P figures the stack of debt, net of state assets, will shrink in the next few years to around 46% of GDP from 51% this year, even as it expects the economy to grow more slowly.

Reducing debt amid slower growth is a tough balancing act. The S&P downgrade calls attention to the challenge ahead.