Kneepads In Tow, Moody's Responds To Dagong's Downgrade Of The US By Upgrading China
Not even 48 hours after Dagong dared to tell the truth about America's sad state of affairs (again) and downgraded the developed world's most insolvent nation for the second time in half a year, Moody's has confirmed that in the creditor-debtor relationship, it is the latter who wears the kneepads. As of a few hours ago, Moody's has upgraded China from A1 to Aa3. The reason cited: "we need China to keep buying our debt" - well, not really, we have the Fed to do that, and in 2 weeks, China's top holding of US paper will be a distant memory. But the last thing the US needs is to piss off the one country whose security dump could be too big even for the Fed to monetize. Ergo: throw Moody's in the wolves' den. After all nobody respects, cares or in any way pretends to even listen to the disgraced and Wells Noticed rating agency (speaking of which, whatever happened to that Wells Notice?).
From a groveling Moody's:
Moody's Investors Service has today upgraded the Chinese government's bond rating to Aa3 from A1 and is maintaining its positive outlook.
The action raises the government's foreign and local currency bond ratings to Aa3 from A1, China's country ceilings for foreign and local currency bank deposits to Aa3 from A1, and the ceilings for foreign and local currency bonds to Aa3 from A1. The short-term foreign currency rating remains at P-1 and is therefore unaffected.
The ceilings act as a cap on ratings that can be assigned to the domestic or foreign currency obligations of other entities domiciled in the country.
The main reasons for the decision are:
1. The resilient performance of the Chinese economy following the onset of the global financial crisis, and expectations of continued strong growth and macroeconomic stability over the medium term.
2. The government's quick, determined and effective stimulus program, the unwinding of which has begun.
3. The lack of erosion in central government financial credit fundamentals, and the likely containment and effective management of prospective, contingent losses arising from the extraordinary credit expansion in 2009.
4. The exceptional strength of the external payments position which provides a substantial buffer to global financial market turbulence and that China's capital controls will help stem de-stabilizing capital inflows.
5. The expectation that trade and currency regime tensions will be constructively managed between China and the US.
Moody's signaled its action today by changing the outlook on China's ratings outlook to positive from stable on November 9, 2009 and by placing the ratings on review for possible upgrade on October 8, 2010.
These actions were justified by events over the course of the past year, during which China maintained a strong, but stable macroeconomic performance.
"In particular, we premised our action on the ability of the Chinese authorities to protect systemic stability from the underlying threats arising from the extraordinary credit expansion evident in 2009," says Tom Byrne, a Moody's Senior Vice President.
"The record of the past year demonstrates that China's policy response to the 2008 crisis has been effective. Real GDP growth initially rebounded rapidly in response to the stimulus measures, and is moderating to a more sustainable rate of growth, which seems likely to be around 9-10 percent this year, and perhaps 8-9 percent in 2011," says Byrne. Although inflation is becoming a challenge, it currently remains moderate, and the PBOC has taken tightening measures in normalizing monetary policy.
The re-balancing of the Chinese economy emphasizing domestic consumption and a somewhat tempered rate of economic growth, if sustained, will also help ensure long-run macroeconomic stability. Indeed, since last year, private consumption has been rising even faster than nominal GDP growth. Moody's expects that trend to intensify with a more rapid rise in wages in the future.
The shift in growth policy is a plank of the upcoming 12th Five-Year Plan, and we expect that the next generation of leadership, when it assumes power in 2012, will follow this economic script. We also expect another smooth, peaceful transfer of power, as took place in 2002 when Mr. Hu Jintao was selected as the Communist Party General Secretary.
The orchestration of an extraordinary economic stimulus program has so far only modestly affected government finances. The budget deficit will likely be contained within 3% of GDP this year and next. Robust revenue growth will likely eclipse that of nominal GDP growth, raising further the ratio of revenues to GDP.
Moreover, direct government debt will likely remain below or around 20% of GDP this year and next. Contingent liabilities on the central government's balance sheet -- arising from the credit surge in 2009 and sharp rises in financing vehicles associated with local-level governments -- are evidently likely to be manageable, based on information currently available.
Government financial strength is bolstered by an ability to finance budget deficits readily and at low cost from the country's large pool of national savings. Unlike the more heavily indebted governments in the Aa-rating range, China does not rely on external financing. Rollover, funding or deleveraging risks are accordingly reduced should the global market appetite for sovereign risk deteriorate.
In addition, with net international financial assets greater than 50% of GDP -- bolstered by about $2.7 trillion in official foreign exchange holdings -- only a handful of highly rated advanced industrial economies, such as Norway, Switzerland, Japan, Hong Kong and Singapore, have a stronger international investment position than China.
RISKS TO THE RATING AND ECONOMIC OUTLOOK
Although Moody's has concerns over the intrinsic, stand-alone strength of China's banking system, we nonetheless recognize that its largest banks have not been materially damaged by the global crisis. Therefore, the dominant banks in the system will not likely pose any sizable contingent liability risk to the government's balance sheet.
Furthermore, we expect that future credit losses -- arising from the surge in lending in 2009, from exposures to the property market, from risky loans to local government financing vehicles, and from off-balance sheet operations in the "shadow" banking system -- will be mostly absorbed by the banks themselves, either from capital, or from future earnings.
However, transparency is still lacking on the extent of such potential losses. While uncertainty persists about the size and soundness of off-balance sheet local government financing operations in particular, we also believe that the central government has ample fiscal headroom to absorb future losses.
Domestic risks would also include an inability of the policy framework to rebalance economic growth, while ensuring that trend growth is maintained at a sufficient pace to ensure employment creation and social stability.
Externals risks to trade relations may be the most threatening over the near term, but conciliatory statements made by Vice Finance Minister Wang Jun and US Treasury Secretary Timothy Geithner in the run-up to the G20 summit in Seoul suggest that tensions over China's exchange rate policy and the US Fed's monetary policy may not escalate out of control. Nonetheless, domestic political pressures will likely keep such issues on the front burner.
In addition, it is noteworthy that China is becoming more of a stakeholder in the international system by assuming a larger role in the IMF, and where its voting rights will rank third, behind only the US and Japan. This also bodes well for a constructive approach to policy differences between China and the US.
CREDIT TRIGGERS FOR A POSSIBLE UPGRADE
These would involve:
1. While to some degree concerns have been allayed through recent discussions with Chinese authorities, greater assurance that local government off-budget financial operations have been contained, and are manageable without imposing a significant burden on the central government's balance sheet and its financing costs would be credit positive.
2. The continued likelihood of success in macro-prudential regulation of the banking sector and property sector to ensure systemic stability without the need for extraordinary support from the government.
3. Signs of success in the policy shift signaled in the recently concluded 5th Plenum of the 17th CPC Central Committee for a rebalancing of China's growth model more towards one driven by consumption, rather than predominantly driven by investment and exports. This would also help fend off external, protectionist pressures.