Thursday, 21 September 2017

S&P Falls in Line with Other Rating Agencies on China: A Reflection of China’s Problems But A Spark for the BRICS Rating Agency Ambitions

Today’s post reacts to the news today that Standard & Poor’s (S&P) have finally fallen in line with the other members of the rating oligopoly (Moody’s and Fitch) in downgrading China’s sovereign debt rating to A+, which puts it one category below the U.S. The reason for this, according to S&P, is that the growing credit bubble in China is systematically reducing financial stability in the country, which seems to confirm fears that recent moves by the Chinese Government to limit the growth of that particular bubble have not taken hold. However, with the BRICS nations calling for the development of their own major rating agency, the news that some analysts suggest that things are moving in the right direction in China despite the recent downgrade may accelerate the plans of the BRICS nations so that the pace of agency development falls in line with the wishes of the Indian Prime Minister who recently made loud calls for an acceleration in that regard. In this post, then, we will look at the recent downgrade and assess whether the effect of that may be the accelerated development of an agency that may provide real opposition to the U.S.-based oligopoly.

The Chinese credit bubble has been written about extensively because, quite simply, the effect of its bursting has the potential to put the global economy into an incredible tailspin. We have discussed this issue before here in Financial Regulation Matters by firstly looking at the regulatory structure in the country, and then at the recent policy moves that are designed to stem the consistent increases in debt being accrued for foreign investments. In light of these issues, the downgrade today to A+ on the basis of China’s ‘prolonged period of strong credit growth’ represents the latest move in a series of downgrades by the Big Three which began with Moody’s downgrade in May earlier this year. There are a number of views on the matter that seem to fall in line with the agencies’ ratings, with Deutsche Bank analysts suggesting that the Chinese credit bubble is the largest risk to global stability and others suggesting that individual components of the Chinese economy could trigger a chain reaction, particularly with reference to the housing-related boom that China is currently experiencing. Furthermore, the Financial Times reports how the growing-but-restrained market for the famous ‘credit default swaps’ (CDS) in China is actually what is allowing the credit bubble to be maintained; the suggestion is that whilst the Chinese finance industry is finding plenty of uses for the CDS market, the lack of sophistication (in part) and the relative uncertainty as to the market’s size is an underlying frailty that may see the bubble ‘pop’ at some unexpected point in the future. Whilst we are now at the point that even Chinese bankers are referring to the ‘bubble’ directly, there are some issues with the rating agencies’ movements that may have some larger systemic effects.

Analysts at the Chinese division of UBS have been quoted as saying ‘China’s debt risk has actually declined over the past year’, with other analysts suggesting that China has ‘room for manoeuvre’ and that its recent policies to restrain the growth of the bubble will have a positive effect. These views are obviously not in line with the downgrades from the agencies which, although admittedly does not necessarily mean the agencies are wrong, does insert an element of doubt into the recent movements. It is this ‘doubt’, for want of a better term, that is the driving force behind the sentiment of the BRICS nations regarding credit rating more generally. This author has written on the BRICS approach extensively, both in the media, in Journals, and also here in Financial Regulation Matters so, in light of that there will not be much examination of the intricacies of the BRICS nations’ aims to develop their own agency to compete against the Big Three in this piece. However, a point raised by an analyst in Beijing hammers home the reasoning for the BRICS nations’ concern over the Big Three and their intentions: Andrew Polk, co-founder of research firm Trivium China, suggested that the downgrade, which comes just weeks before the twice-a-decade reshuffle in China’s political infrastructure, ‘may feel like potentially the international community is piling on that will be frustrating’. It is this feeling that the Big Three, despite their claims of independence, are actually vehicles for U.S. or Western policies that is the biggest fear for the BRICS nations, and movements like S&P’s, particularly in relation to its timing, will only cement those fears.

It is on the basis of those fears that the Indian Prime Minister, Narendra Modi, recently attempted to accelerate the development of the BRICS-established rating agency. This author has spoken before about the most obvious impediment to the success of such an agency – the feared perception of political influence – but the Indian PM has been forthright in his advocacy for the creation of the agency, as soon as possible, to aid integration with the leading financial entities like the IMF from a position of strength. However, the other members of BRICS were not so adamant, with China being the first to note the credibility-related issues that was mentioned above, although China does welcome the increased research into the developed agency’s viability. Yet, this latest move by the rating agency oligopoly may reverse such sentiment on China’s behalf. The downgrade by Moody’s in May was criticised heavily by China as being fundamentally flawed with regards to its methodology and sentiment, and it will be particularly interesting to observe whether China’s maintenance of support for the Big Three after Moody’s rating is continued in light of S&P’s rating today.

Ultimately, China has yet to flex its muscles in the arena of credit ratings, and today’s rating may be seen, in time, as the event which altered China’s stance irrevocably. India’s advocacy for a BRICS rating agency has been tempered by the reluctance of China because, although the internal dynamics of the BRICS-bloc is quite another story altogether, it is arguably the case that China is the leading figure in that collection of developing powerhouses; Putin’s battles with the agencies have still not precipitated the development of the new agency, which suggests that only Chinese influence can raise the BRICS rating agency idea off the ground. Whilst China may take issue with the downgrade, they will know that the growing concern regarding their credit bubble is likely a very reasonable basis for the downgrade – however, it is the timing which will cause the most anger, and arguably this is entirely justified. The political system in China, which is obviously much different to Western political systems, is dominated by the movements of the Politburo at certain times in its cycle and the setting of October the 18th for the 19th National Congress is an extremely important juncture in the power dynamics in Beijing. It is against this backdrop that S&P, falling in line with its American-based oligopolistic colleagues have decided to act, and in doing so they risk provoking an opponent that has the means and wherewithal to seriously affect their position – this is not to say that rating agencies should be fearful of those they rate, but the timing of their releases must be a factor if they are to maintain their dominance. This author has been emphatic in criticising the agencies with regards to their arrogance within the financial arena and their aiming for the Chinese is just the latest demonstration of that arrogance – the effect of that will be fascinating to observe.

Keywords – China, Credit rating agencies, Sovereign debt, politics, BRICS, Communist Party National Congress, India, credit, credit bubble, @finregmatters

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