Beijing is “disappointed.” With a lot of things and also with a lot of people, but on Tuesday with Moody’s.
The ratings agency cut its outlook for the country’s credit rating to negative from stable, citing the likelihood that a shrunken property sector means less revenue for regional and local governments, some of which could “face financial strain for the foreseeable future,” imperiling their capacity to support local government financing vehicles and other local state-owned enterprises.
That’s a problem because it’d suggest the federal government and the “wider public sector” will have to step in to provide support, “posing broad downside risks to China’s fiscal, economic and institutional strength,” Moody’s said.
The decision, which leaked on WeChat hours before the official release, pushed Mainland shares to their fourth-worst day of 2023.
The news was insult to injury for Xi’s China, which had a rough year. The much discussed re-opening boom never materialized, and many argue Xi’s domestic policies have permanently undermined the economy’s potential. Prior to the pandemic, most assumed China would overtake the US economically within two or three decades. Now, such an outcome is increasingly seen as unlikely.
Moody’s painted the situation as a kind of “damned if they do, damned if they don’t” dilemma. Supporting regional governments and local SOEs comes at a cost, but not supporting them isn’t an option either. Worse, trying to find a middle ground could mean incurring fiscal risk with little to show for it.
“While not all SOEs are likely to need direct government support, even a moderate proportion doing so over the medium-term would represent a significant crystallization of contingent liabilities for the sovereign, increasing the costs of financial support and diminishing fiscal strength,” the rationale read. “Furthermore, ensuring that support to local government or SOE debt happens in a timely and orderly, yet targeted fashion in a way that supports growth and investment represents a significant policy challenge.”
Moody’s went on to describe recent measures as mere palliatives. “The amounts at stake are small relative to the size of LGFV and local SOE debt potentially at risk, and their one-off and short-term nature means that they do not address local government debt sustainability issues,” the assessor said, on the way to citing “significant execution risk” around longer-term efforts to offset a smaller role for the property sector in the overall economy, risks which are likely to be “exacerbated by unpredictability surrounding how and what reform measures will be taken.”
In the near-term, downside risks persist, particularly around the property sector. Xi’s efforts to shrink it represent “a major structural shift in China’s growth drivers,” which could morph into “a more significant drag to China’s overall economic growth rate than currently assessed,” a scenario which would worsen debt sustainability at the local level.
Moody’s sees the Chinese economy growing at a 4% clip in 2024 and 2025. The average annual growth rate for the remainder of the decade should be 3.8%, the agency said Tuesday.
In a terse statement expressing dismay with the decision, Beijing countered that the Chinese economy “has large potential.”
On the bright side, the US and China now have something in common at a time when the world’s two superpowers are struggling with mutuality: A Moody’s outlook cut the government doesn’t agree with.
A wise man used to say that humans have a tendency to claim we’re unequivocally better off than our ancestors, and that we all worship at the altar of growth, without which the world would likely be a more primitive place. As much as you do, I dislike Xi’s China. But if Xi’s efforts to shrink the property sector translate into lower home prices, then the average Chinese should be happier, no? Sure, all of the ‘happiness’ from lower home prices could easily be offset by the psychological impact from the 3-yr lockdown. But that’s another matter (I dislike Xi for that, and Taiwan, of course). I think we can find common ground on the notion that the world’s a better place without persistent home price growth. All of his ‘evilness’ aside, there’s a sense in which Xi is really concerned about the socially deleterious effects from elevated home prices and that he’s committed to arresting the trend, even if it means losing momentum in the superpower race. That’s to say he’s probably more concerned about domestic inequality gap than about moving past the US on the world’s stage. And besides, can we really say for sure that an average American is more happy than an average Chinese?
I’m not Chinese, by the way.