19 March 2019
US regulators have snubbed Dagong, which has shown no reluctance, unlike its western counterparts, to downgrade its rating of US sovereign debt. Photo: Bloomberg
US regulators have snubbed Dagong, which has shown no reluctance, unlike its western counterparts, to downgrade its rating of US sovereign debt. Photo: Bloomberg

China’s outlook downgrade and the case for global rating reforms

Last month, the leading credit rating agencies cut their outlook for China’s sovereign credit rating from stable to negative.

If the decision was warranted, it may also be time to reassess the current ratings of most advanced economies and accelerate global rating reforms.

Standard & Poor’s revision followed a similar move earlier in March by Moody’s Investors Service.

Nonetheless, the outlook revision was strongly criticized by Chinese officials and media outlets.

As a Xinhua commentary put it, China’s economic growth is decelerating amid a painful transition. However, a revision of outlook is not warranted, as “the fundamentals of the Chinese economy remain sound and solid and are improving”.

Was the revision warranted?

Rising criticism against credit agencies

Credit rating agencies (CRAs) assign credit ratings, which rate a debtor’s ability to pay back debt by making timely interest payments, as well as the likelihood of default.

The issuers include companies, special-purpose entities, non-profit organizations and also sovereign nations, state and local governments.

In the past two decades, the criticism of the leading CRAs has increased in the advanced economies, starting with the internet bust of 2000-2001, the subprime mortgage crisis after 2005, the global financial crisis in 2008-2009, when hundreds of billions of securities that had the CRAs’ highest ratings were downgraded to junk, and the European sovereign debt crisis since spring 2010, when Brussels blamed rating downgrades for escalating the crisis.

As the major advanced economies no longer fuel global growth, large emerging economies — China, India, Russia and Brazil, among others — play an increasing role in these prospects.

In these economies, criticism against the large rating agencies has also increased since the Asian financial crisis of 1997-1998 and recent downgrades that reflect substantial capital outflows and other challenges.

In advanced economies, criticism focuses on the CRAs’ professional conduct.

In emerging and developing economies, it also addresses the issue of fairness.

As the past two decades suggest, the CRAs are not immune to professional biases, moral hazard and conflicts of interests.

Critics say the problem stems from the extraordinary concentration of the CRA industry.

Influential reports in the early 2010s said the two largest US-based CRAs — S&P and Moody’s — controlled about 80 percent of global market share.

The “Big Three” — S&P and Moody’s plus Fitch Ratings, which is dually headquartered in the United States and Britain and majority-owned by a French holding company — dominate 95 percent of the credit rating business around the world.

Sovereign ratings and sovereign debt

At the moment, China’s sovereign debt is adversely affected by local debt, not by the central government’s debt.

It is not the result of a long historical process, which is the case in the advanced economies.

Rather, most of it was accrued as an unintended side effect of the large stimulus package of 2009. 

That stimulus did sustain confidence amid the global crisis; it contributed to infrastructure in China; it spared advanced economies from a second Great Depression; and it enabled global growth at a time when it was most desperately needed.

Yet, it also resulted in excessive, inadequately managed liquidity, which generated huge challenges in property markets and local debt.

So, the government has engaged in a balancing act and structural reforms that seek to defuse the debt challenge in the medium term while ensuring adequate growth in the short term.

If the “Big Three” see a revision in China’s outlook as warranted, that raises the question whether the ratings of most advanced economies remain justified.

Without effective growth, major advanced economies rely on ultra-low interest rates (the US), continued quantitative easing, or both (Europe, Japan).

Despite their high credit ratings, these economies have high, even excessive, government-debt-to-gross-domestic-product levels, as evidenced by Japan (close to 250 percent), Italy (over 130 percent), the US (105 percent), France (over 95 percent), Britain (90 percent) and Germany (over 70 percent).

Toward global rating reforms

The assumption is that these sovereigns are able and willing to repay their debt.

Yet, despite the deleveraging rhetoric, in most cases the debt burden is actually increasing.

Japan’s rating is AA- (the same as China’s), even though its debt burden is twice as large in relative terms as that of Italy, which S&P has downgraded to BBB-, the closest to junk.

The US rating is AA+, although its debt burden in relative terms is significantly higher than that of France, whose rating is AA.

The US debt burden exceeds US$19.2 trillion, which means that the country must pay US$2.4 trillion annually in total interest — more than the largest budget items (Medicare/Medicaid, social security and defense) put together.

America also lacks a credible, bipartisan and medium-term debt-reduction plan, which would seem to contradict the S&P requirement that a country is not just able but willing to repay its debt.

Finally, Britain and Germany continue to enjoy AAA ratings although their public debt level is in relative terms twice as high as that of China.

Since the global financial crisis, the Chinese credit rating agency Dagong Global Credit Rating Co. Ltd. has downgraded its rating for the US several times.

Meanwhile, in 2010 the US Securities and Exchange Commission rejected an application by Dagong to enter the US marketplace.

In the advanced economies, the argument is that Dagong reflects Chinese interests.

Yet, the argument that the “Big Three” reflect the interests of major advanced economies is discounted there.

Unlike the large CRAs, Dagong and China are committed to reshaping the global credit rating system.

Over time, that is very much in the interest of the international community.

Consequently, these reforms are supported by a rising international consensus.

Global sovereign ratings are far too important to remain a monopoly reserve of a few major advanced economies whose high-level debt poses a rising risk to global stability and prosperity.

For more of Dr. Dan Steinbock’ articles, see

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Dr Dan Steinbock is the research director of international business at the India, China and America Institute (USA) and a visiting fellow at the Shanghai Institutes for International Studies (China) and at EU Center (Singapore).

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