Date
26 May 2017
Investors should avoid the long-term bonds of fragile sectors like raw materials and heavy industries. Photo: Xinhua
Investors should avoid the long-term bonds of fragile sectors like raw materials and heavy industries. Photo: Xinhua

China’s sovereign credit rating likely to be downgraded

Back in February, we said that China’s support measures to stimulate short-term economic growth would have a negative influence on the country’s sovereign credit rating. 

Such short-term policies are likely run counter to the long-term objectives of deleveraging and destocking.

We said there’s a growing possibility that the country’s credit rating would be downgraded from the present AA minus in the next 12 months.

On March 2nd, Moodys’ downgraded China’s rating outlook from stable to negative due to its expected weaker fiscal power, higher leverage, and stagnation of structural reforms in the economy.

The rating agency will review China’s sovereign rating in the next six to 12 months.

After the move, prices of credit default swaps and spot bonds showed almost no reaction at all. It means the market has already priced it in.

The stable performance of spot bonds is due to the fact that the majority of holders are local investors, while the offshore market is relatively small.

Thus, strong demand from the onshore market and ample liquidity in the offshore market would support the price.

The size of offshore dollar-denominated bonds issued by Chinese firms is about US$260 billion to US$270 billion. That of China is worth about US$7.4 trillion.

The prices of China’s sovereign CDS have long gone beyond the reasonable range for an AA minus rating. They’re closer to the price of an A-rated bond.

China’s sovereign five-year CDS spread with that of South Korea’s has widened to the highest level since 2013, reflecting the growing feeling of uncertainty among investors about China’s economic reform.

We don’t think a potential downgrade would lead to a debt crisis because China’s external debt accounts for less than 5 percent of its total debt.

Investors should avoid the long-term bonds of fragile sectors like raw materials and heavy industries because they have weak fundamentals and are only backed by the sovereign credit rating to maintain their present credit levels.

As for banks, we are positive on the 10-year tier-2 capital bonds that will mature in five years, as it offers better risk return than the banks’ senior debt and additional tier-1 capital debts.

To achieve its short-term growth target, China is likely to continue launching supportive policies.

We can see the clues from the high growth rate of banks’ financing data in January and the expanding total social financing scale.

If the trend continues, we believe it would weigh on government efforts to deleverage and destock and the country’s sovereign credit rating would also be affected.

This article appeared in the Hong Kong Economic Journal on March 9.

Translation by Myssie You

[Chinese version 中文版]

– Contact us at [email protected]

MY/DY/CG

EJI Weekly Newsletter

Please click here to unsubscribe