Luo Zhiheng et al.: Moody's natural attributes make it impossible to accurately understand China's economy

　　China-Singapore Jingwei, December 10 (Xinhua) -- Moody's natural attributes make it impossible to accurately understand China's economy

　　Author: Luo Zhiheng, Chief Economist and Dean of the Research Institute of Yuekai Securities

　　Cheng Jiayi, Research Assistant of Yuekai Securities

　　Against the backdrop of international institutions raising China's economic growth forecasts, Moody's downgrading the outlook of China's sovereign credit rating has attracted widespread attention in the market. In our view, Moody's downgrade of China's sovereign credit rating outlook is biased and has three major miscalculations. Moody's downgrade outlook will not have a significant impact on China's stock market and economy, and China's economy will continue to recover from the pandemic in 2024 thanks to a series of policy support and reforms.

　　On December 5, Moody's Ratings released its latest sovereign credit rating for China, maintaining its rating at A1 but revising its outlook to negative from stable. Moody's downgraded the outlook for eight Chinese banks, 22 Chinese urban investment companies, and 18 Chinese infrastructure state-owned enterprises and rated subsidiaries to negative from stable after adjusting China's sovereign rating.

　　According to Moody's rating definition, a negative outlook indicates a high probability of rating change in the medium term, which is mainly a warning effect. Normally, after the first positive or negative rating outlook, the next rating outlook and rating re-evaluation will take place within a year or so. Historically, about one-third of issuers have experienced a corresponding rating adjustment within 18 months of the revised outlook.

　　Moody's sovereign credit rating methodology mainly considers four aspects: economic strength, institutional and governance strength, fiscal strength, and sensitivity to risk events. Judging from the main points of discussion in the Moody's Rating Committee on November 30, the main issues focused on concerns about the significant decline in the strength of China's fiscal and debt position. Moody's downgraded its outlook for three main reasons: the central government's financial support for SOE financing vehicles to resolve debt problems, which would weaken the country's fiscal strength, the downside risks to real estate that could weigh on China's economic growth in the medium term, and the structural decline in China's economic growth in the medium term due to factors such as an aging population.

　　We believe that Moody's has a poor understanding of China's national conditions and economic operation, but China's system is quite different from that of European and American countries, and its evaluation model does not fully take into account the factors that affect the differentiation. We don't think any of the three main reasons for Moody's downgrade are valid.

First, Moody's does not have a good understanding of the complexities of China's fiscal situation. In recent years, China has continued to promote the prevention and resolution of local government debt risks, strengthened supervision and regulation of local financing behavior, state-owned enterprise reform and other measures have been quite effective, and the leverage ratio of local state-owned enterprises and financing platforms has gradually improved, and at the end of 2022, the Ministry of Finance said that more than one-third of the stock of implicit debt has been resolved. After the "package of debt solutions" was proposed at the meeting of the Political Bureau of the CPC Central Committee in July 2023, various localities actively promoted the resolution of implicit debts in the region through fiscal and financialized debts. The central government has given a clear explanation of the scope, disposal method and source of funds for local governments to resolve hidden debts, resolutely curbing the increase while resolving the stock of hidden debts, and proposing that "the province shall bear the overall responsibility, and the local party committees and governments at all levels shall bear their respective responsibilities", so as to control the debt risk within the provincial scope as much as possible. Local governments are still the main body responsible for debt reduction, and the overall hidden debt risk is controllable. At the same time, China's debt is backed by a large number of high-quality assets, including infrastructure and a large number of powerful state-owned enterprises and state-owned enterprises, which can bring long-term economic returns, which is significantly different from the economic structure of European and American countries that rely on consumption and finance, and these assets should be taken into account when assessing China's financial situation, so as to make a more comprehensive and objective judgment.

Second, Moody's may overestimate the downside risk to real estate. Recently, high-level meetings such as the Central Financial Work Conference have mentioned meeting the reasonable financing needs of various real estate enterprises, supporting the demand for rigid and improved housing, and accelerating the construction of "three major projects" such as affordable housing. Standard & Poor's, one of the three major international rating agencies, is more positive about China's real estate, and released a report in October that China's real estate industry is about to bottom out and will gradually recover in 2024.

Third, Moody's is biased in its assessment of China's economic growth. In November, the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) both raised their forecasts for China's economic growth in 2023 to 5.4% and 5.2%, with China's economic growth rate remaining ahead of the world. At the same time, international financial institutions such as JPMorgan Chase and Goldman Sachs have also raised their forecasts for China's economic growth, reflecting that China's economy still maintains strong resilience and potential against the backdrop of sluggish global economic growth and complex and severe international relations, and will continue to be an important driving force for global economic growth in the future. In contrast, Moody's gives a low judgment on China's economic growth, with GDP growth expected to be 4.0% in 2024 and 2025, significantly lower than the forecasts of most international organizations and financial institutions.

　　However, Moody's rating outlook adjustment is not entirely negative for China's economy. The main reasons for maintaining the A1 rating include the shift in the economic structure to technological innovation and high-end manufacturing, which will boost productivity and GDP growth, the fact that China's economy will grow at slower than expected but relatively stronger than other A-rated sovereigns, and China's institutional and governance capabilities that have withstood many historical tests and are able to effectively mobilize significant resources to cope with fiscal pressures.

Therefore, we should take an objective and rational view of the downgrade, which has a limited negative impact on China. Historically, previous downgrades of Moody's ratings or outlook have not had a significant impact on the trend of China's stock market, bonds, and exchange rates at that time. The downgrade of the rating outlook of international rating agencies is more of an impact on public opinion and may have a certain impact on overseas financing, but China's current external debt is at a very low level compared with most large countries, accounting for about 50% of GDP in 2022, which is lower than the international warning line of 60%. Even when implicit debt is taken into account, China's debt ratio is still much lower than that of major economies such as the United States and Japan, and its large foreign exchange reserves and net creditor status are strong guarantees for its ability to repay external debt.

　　China's real GDP grew by 5.2% year-on-year in the first three quarters, and we expect China's economic growth to reach around 5% in 2024, and generally continue the post-pandemic recovery trend in 2023. (Sino-Singapore Jingwei APP)

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