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China faces possible credit rating downgrade if the trade war isn’t resolved

Escalations in its trade dispute with the U.S. not only could dent China’s economy but also negatively impact its credit standing, according to ratings agencies. China’s  faces a weakening economy and a high-stakes tariff battle with the U.S.Should the impasse linger on, the damages could become greater and start having some deeper impacts.

  • Its trade war with the U.S. could damage both China’s economy and its credit rating if it lingers on, ratings agency DBRS said.
  • China’s debt is rising, and it might respond with more monetary easing if it can’t reach an agreement with the White House.
  • Other ratings agencies also have warned about deterioration to China’s standing.

“The tariff war is negative for China especially at a time when its policy makers are battling problems of rising debt and increasing leverage in its economy,” analysts at ratings agency DBRS said in a note. “The economic impact on China of rising tariffs would be broader than just via its trade with the U.S.”

“The economic impact on China of rising tariffs would be broader than just via its trade with the U.S. (China’s exports to the U.S. account for 19% of China’s total exports or 4% of China’s GDP). It will also have an income effect on both consumption and investment. Higher tariffs could impact profit margins, thereby reducing investment, employment and household income. Moreover, concerns about uncertainty in the U.S.-China relationship could also result in an accelerated pace of the relocation of supply chain components outside China. Fears over slowing growth and trade tensions could prompt further monetary and fiscal easing and result in China’s debt-to-GDP ratio rising in the coming years. (see: DBRS China’s Increasing Debt – It’s the Mix that Matters, May 1, 2019)”

China Credit Ratings, May 19, 2019
 Implication: On March 21, DBRS placed China’s A (high) rating on a Negative trend (see: DBRS Confirms China at A (high), Trend Changed to Negative, March 21, 2019). This reflects DBRS’s view that downside risks are growing as China prioritizes near-term growth objectives over the need to curb credit growth. DBRS will continue to monitor measures taken by the Chinese government that may increase financial risk exposure among corporate and local government sectors

KEY RATING CONSIDERATIONS

The Negative trend reflects DBRS’s view that downside risks are growing as China prioritizes near-term growth objectives over the need to curb credit growth. Since the last review, amid a domestic slowdown and a deterioration in U.S.-China relations, Chinese authorities seem to have paused deleveraging efforts as they look at ways to maintain growth in line with policy targets. Continued build up in leverage may increase risks of a decline in private sector demand and in financial stability. In spite of China’s extensive policy levers and ample resources, its buffers are eroding. If faced with a mix of capital flight and weaker domestic demand, it is unclear whether the effectiveness of existing policy levers will be maintained. Furthermore, while a trade deal with the U.S. is forthcoming, recent developments have changed dynamics between the two nations and both countries must now grapple with new approaches to competition and cooperation.

China’s current ratings reflect its large and diversified economy, strong external balance sheet, moderate public debt, and high domestic savings. China is the world’s top merchandise trader, the second largest economy with GDP at US$ 13.6 trillion, and accounts for roughly one-third of global growth. Decades of rapid income growth have created one of the largest consumer markets in the world. China’s A (high) ratings are nonetheless hindered by structural credit challenges. China’s main policy challenge is the need to shift its growth model from an over-reliance of credit intensive investment towards domestic consumption and services. While there is evidence of some progress towards deleveraging especially in curbing shadow lending, financial vulnerabilities remain elevated, warranting additional measures for containing high leverage, reducing local government deficits, and improving transparency. BIS estimates of China’s gross debt have risen from 140% of GDP in 2007 to 255% in Q3 2018. The IMF estimates of the ‘augmented’ deficit (which includes off-budget items) averaged 7.7% during 2013-2015, but rose to 10.6% during 2016-2018. Moreover, the consolidation of power and the reduction of checks at the top level of the central government increases the risk of policy errors that could exacerbate imbalances in the future.

 

Sources:

https://www.cnbc.com/2019/05/17/china-faces-possible-hit-to-credit-rating-if-the-trade-war-isnt-resolved.html

https://www.dbrs.com/document/345161.pdf?

https://www.dbrs.com/research/342480/dbrs-confirms-china-at-a-high-trend-changed-to-negative

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