Concerns about China’s “massive debt burden” and slowing economy are causing new concerns after Moody’s Investor Services sounded a full-blown alarm this week downgrading China’s credit rating on sovereign debt from Aa3 to A1.
Why would Moody’s cut China’s rating now for the first time since 1989? Marie Diron, an associate managing director in the Moody’s risk department, explained, “The downgrade reflects Moody’s expectation that China’s financial strength will erode somewhat over the coming years, with economy-wide debt continuing to rise as potential growth slows. While ongoing progress on reforms is likely to transform the economy and financial system over time, it is not likely to prevent a further material rise in economy-wide debt and the consequent increase in contingent liabilities for the government.”
Put simply, China’s economy is slowing, and its financial position is deteriorating because the government is spending too much money to try to sustain rapid growth. More fundamentally, President Xi isn’t shifting China into a market economy as fast as Moody’s thinks he should.
Yes, the Chinese economy is slowing. Its GDP is now expanding by 6.5 percent and 7.5 percent. The years of 10 percent growth are indeed gone, boosted by massive debt-ridden government stimulus.
Even so, when you compare China to other developed countries the macroeconomic numbers as reported seem reasonable. China’s forex reserves, at $3 trillion, are larger than the entire German economy. Government debt weighs in at 43 percent of GDP. U.S. government debt, to put this in perspective, is about 104 percent of GDP. For Britain, the figure is about 90 percent.
But total debt in the economy, public and private, is the real issue. In China, it’s about 250 percent of GDP. Sound high? It compares with 600 percent in Japan and 380 percent in the U.S.
What about external debt? Again, it’s hard to see what’s to fret about. China’s external obligations are 12 percent of GDP, but 20 percent of that is denominated in renminbi, which pushes debt owed in foreign currencies to less than 10 percent of GDP—enviable by any measure. China now runs a current-account surplus equal to 2.6 percent of GDP—the dream of any fiscal hawk. It’s a deficit in the U.S. case—oddly enough, the same 2.6 percent of GDP last year.
As the world’s No. 2 economy matures, it’s growth is supposed to slow to long-term sustainable levels. Even though government debt was stable in 2016, and the finance ministry forecasts no increase in risk in the 2018–2020 period, that’s not the whole story.