Standard & Poor’s China rating downgrade makes no sense
How any supposedly objective credit-rating agency downgrades a country’s creditworthiness when its financial position is stronger and more stable than those of the developed countries, as Standard & Poor’s did recently, is beyond comprehension.
This author has noted in response to a previous downgrade by Moody’s Investors Service that China’s total debt-to-GDP ratio was between 250% and 280% depending on whose figures one believes, while those of the Group of Seven developed nations ranged from 260% to 571%. And the majority of loans in China were (and still are) owed to Chinese state-owned banks by state-owned enterprises (SOEs), suggesting that the government is lending to itself.
China’s external debt is only around US$1.4 trillion, far lower than the G-7 average of $6 trillion and the United States’ $19 trillion, indicating that its companies or governments require little if any borrowing from foreign financial institutions.
According to the China Banking Regulatory Commission, commercial-bank assets have reached $36.75 trillion, a year-on-year increase of 11.5%, and non-performing loans accounted for 1.74% of the total in the first half of 2017.
Risk comparison between G-7 and China
The debt problem in the G-7 in general and the US in particular does not look like going away any time soon. With the group’s average annual growth rate of less than 2% is expected to linger (because of rising protectionism and populism), the G-7 nations are forced to rely on borrowing to finance domestic programs.
In the US, the catastrophic hurricanes Irma and Harvey recently destroyed much of Houston and major cities in Florida, which are said to require between $150 billion and $200 billion to rebuild. The US Congress raised the government’s debt ceiling by $20 billion, pushing the government debt over $20 trillion.
With President Donald Trump’s desire to raise defense spending, to build a wall along the Mexican border (good luck getting Mexico to pay for it), an estimated $1 trillion in infrastructure expansion and repair, and expected huge social-program needs, the US government debt could surge in the coming years. The US borrows money for similar reasons as China’s.
Huge government and private debts and ineffective monetary policies make it difficult for the other G-7 countries to climb out of their economic holes. Worsening their economic and social problems are generous pension payments and large inflows of refugees. The United Kingdom has a problem of real wage reduction because Brexit has depreciated the pound, eroding consumption even more.
Exacerbating the economic and financial woes is rising protectionism and populism on both sides of Atlantic: Trump’s “America First”, the UK’s Brexit, and rising popularity of far-right political parties in Europe. Such countries are caving in to popular demand for restricting imports and immigration, which would stifle rather than enhance growth.
On the other hand, China’s economic growth has defied Western predictions and in fact is on an upward trajectory. International organizations such as the International Monetary Fund and the Asian Development Bank have revised their 2017 growth projections from 6.0% to 6.7%. Their reasons lie in China’s first half-growth of 6.9% due to effective reforms, steady or prudent macroeconomic policies, and the promotion of globalization.
Nature of Chinese debt spending
Rising local-government and corporate debts in China are largely for spending on projects that promote competitiveness and economic growth. The central government is pledging to spend more than $350 billion on green energy, nearly $1 trillion on infrastructure expansion and improvement, $20 billion on poverty alleviation and 2.5% of gross domestic product on innovation over the next five years, just to name a few examples.
The new roads, railways, houses and other assets will contribute to economic growth in both the short and long terms. Additional workers and production of industrial goods are needed to build the assets. They in turn will create a multiplier effect, expanding opportunities for supporting or tertiary industries (such as retail and hospitality).
Once completed, the new roads will attract investment. New roads and a high-speed railway connecting Lanzhou, capital of northwestern China’s Gansu province, to Urumqi, capital of the Xinjiang Uyghur Autonomous Region, have accelerated tourism to stimulate economic development in the far western provinces.
S&P’s flawed, inconsistent logic
The classical economic theory that rising debt can raise economic and financial risks may have merit, although it is questioned by some economists. Increasing government debts, according to classical economists, could “crowd out” private investment by raising interest rates and taxes. By this logic, S&P and other credit-rating agencies may be right in downgrading a country’s (or company’s) credit rating.
But that posture is not applied consistently to every country or company. The G-7 nations are given triple- or double-A credit ratings even though their debt issues are just as worrisome if not more so than those of China. Worse, the granting of triple-A ratings to investment-bank derivatives (collateral debt obligations and credit default swaps) during the era leading up to the 2007 financial crisis was beyond economic and financial logic. Such ratings prompted many investors to default on payments, probably the biggest single cause of the crisis.
Meanwhile, the argument that because China is a developing country and therefore less able to pay debts (than developed ones) is not convincing.
Corporations own more than half of the estimated $21 trillion in bank deposits in China, suggesting that they are really borrowing their own money, or at least most of it. Local governments that guarantee loans on private-public-partnership projects own the banks and land on which the assets are built.
What’s more, the central government has been able and quick to cull excessive credit expansion because it controls local-government finances and owns the major banks and SOEs.
Applying neoliberal economic tools, the UK-based Economist and Financial Times along with their US counterparts The New York Times, Forbes and others have been predicting a Chinese economic hard landing since the late 1980s. Even prominent scholars have jumped on the “China collapse” bandwagon. Moody’s downgraded China’s credit rating in March for the same reasons as S&P. But instead of a hard landing or showing signs of economic and financial stress, the Chinese economic and financial system is in fact growing stronger by the year.
China’s economic and financial posture is different from Anglo-American neoliberalism. Its “socialism with Chinese characteristics” in which SOEs and private enterprises co-exist is unique.
SOEs dominate the strategic or essential sectors such as energy, banking, and others to ensure socioeconomic stability, not profit-maximizing. Despite some mal- or over-investment, the benefits of universal access to essential goods and services and maintaining high levels of employment are major reasons for sustainable economic growth in China.
Keeping workers employed even if it means lower profits for the SOEs sustains short- and long-term economic and social stability. In the short term, workers receive a paycheck, allowing them to spend and save. In the long term, accumulating savings increase investment funds to ensure long-term economic growth and social stability. In any event, SOEs are making profits, though not at the rate neoliberalism dictates.
A final comment
S&P’s China credit downgrade, like that of Moody’s, is not only wrong, it could hurt the agencies’ credibility even more. Many multinational firms have lost trust in them because of the pre-crisis rating blunder. Investing firms use alternative or their own information sources to assess China’s economic outlook, explaining why Ford Motor, Dell, Boeing and others are more optimistic on China.
Western pundits are consistently wrong on China’s economic outlook because of questionable assumptions and facts, ideological bias, and a lack of understanding of the country’s economic economic and financial architectures.
Still, time will tell whether China’s economy will encounter economic and financial risks or collapse. But as John Maynard Keynes sarcastically remarked, “In the long run we are all dead.”