In a further blow to China’s economy, credit rating agency Moody’s announced on Tuesday that it had issued a negative outlook on the Chinese government’s fiscal health.
Moody’s expressed concern that bailing out indebted local and regional governments and state-owned enterprises could come at the expense of the central government. Moody’s had previously viewed China’s finances as stable, but warned that the country’s huge real estate sector was starting to shrink while the country’s economy was settling into slower growth.
China’s Ministry of Finance quickly pushed back, saying China’s economy is resilient and local government budgets can withstand revenue losses from the real estate downturn.
At the same time, Moody’s reaffirmed the overall credit rating for the Chinese government at ‘A1’, which is about midway through the scale of what is considered ‘investment grade’ or generally low risk. A negative credit rating outlook does not necessarily result in an immediate downgrade, but it does serve as a warning that the existing rating may not be sustainable.
Still, the credit outlook downgrade marks an important milestone for China’s economy.
Until recently, China had the world’s largest bullet train network, a massive military buildup, subsidies to manufacturers, and unlimited funds for massive overseas construction projects.
Currently, China is facing increasingly severe budget constraints, mainly due to the sharp decline in the real estate sector. Construction of apartments, factories, office buildings, and other projects is the country’s largest industry, accounting for 25% of economic output. An apartment is also a major investment for most households, accounting for more than three-fifths of their savings.
Although borrowing by the Chinese government is limited, local governments and state-owned enterprises have borrowed heavily over the past 15 years. The funds that local governments have withdrawn from lenders have generated rapid economic growth, but many of them are now in dire straits.
For China, changes in the credit outlook will have little direct fiscal impact. Unlike many countries, China relies little on foreign borrowing. The central government primarily sells bonds to state-owned banks. The country’s local governments and state-owned companies also sell bonds.
During the global financial crisis of 2008 and 2009, when the U.S. housing market suffered a sharp correction, the Chinese government emphasized China’s economic leadership. China is currently facing a similar, and perhaps even bigger, housing recession. Dozens of major real estate developers have gone bankrupt, unable to complete hundreds of thousands of apartment units for which they had already accepted huge deposits.
Developers have left small businesses and other contractors with hundreds of billions of dollars in overdue bills, triggering a series of payment troubles. With the exception of some state-owned companies, developers have largely stopped purchasing land for future housing construction.
Land sales were the main source of income for local governments. Revenues from these sales have plummeted and many are now facing crisis. Moody’s said in a statement on Tuesday that the central government will likely need to help these governments cope.
Difficulties in the real estate sector are holding back economic growth, increasing youth unemployment and leaving many families worried about spending their money.
“The change in outlook also reflects increased risks related to the structural and sustained decline in medium-term economic growth and the continued contraction of the real estate sector,” Moody’s said.
China’s Ministry of Finance rejected Moody’s claims. The report said that while local governments are receiving less income from land sales, they are also spending less to compensate residents whose homes have been demolished to make way for new buildings. The ministry also asserted that China’s economy still has considerable momentum.
China is not the only country that has Moody’s concerns. Last month, the agency lowered the U.S. credit outlook to negative while reaffirming the country’s top AAA rating.
Relative to the size of its economy, China’s overall debt is now higher than that of the United States.
China’s credit rating was last downgraded by both Moody’s and S&P Global Ratings in 2017. Recently, S&P has expressed less concern than Moody about China’s economy. Hours before Moody’s announcement on Tuesday, S&P said it believed China could avoid a repeat of Japan’s “lost decade” when economic activity slumped in the wake of the housing recession in the early 1990s. .
Fitch Ratings told Bloomberg TV earlier this year that it might reconsider credit scores for Chinese government bonds, but recently affirmed the rating with a stable outlook.
China’s economy has endured a bumpy ride this year as a result of nearly three years of strict “zero coronavirus” measures, including many of the world’s longest and strictest lockdowns.
The economy grew at an annual rate of 5.3% from July to September.A surge in investment by debt-driven manufacturers was offset by fairly robust spending at restaurants and hotels. A decline in condominium construction.
Data for October and November are mixed. Investment in new factories producing electric vehicles and other advanced products continues to be active. But the arrival of the cold wave has unleashed a wave of respiratory illnesses across much of China, initially among children but also among adults. This has left many restaurants and other service industry establishments empty.
Moody’s said the sheer size of China’s economy, the world’s second largest after the United States, gave it considerable ability to absorb shocks. The Treasury agreed, saying: “The long-term positive fundamentals remain unchanged and will continue to be an important driver of global economic growth.”