Fitch downgraded China’s long-term local currency rating from AA- to A+, citing a number of “underlying structural weaknesses” in the Chinese economy including low average incomes, lagging standards of governance, and a rapid expansion of credit.
The agency also warned of the growing risks from the rise of shadow banking, and said that total credit in China may have reached 198 per cent of gross domestic product by the end of last year, up from 125 per cent in 2008.
“Ultimately we think China’s debt problem is going to require sovereign resources to resolve and debt will migrate onto China’s sovereign balance sheet. We don’t yet know what form this will take – central bailouts of local governments or of banks, perhaps”, said Andrew Colquhoun, head of Asia sovereign ratings at Fitch.
The downgrade does not come entirely a surprise. There has long been a perception that China's public debt is understated, partly because debt raised by provincial and other agencies are not included, but mainly because China uses state-owned banks to lend in a big way to state-owned enterprises and public projects. In effect, this buries public debt in banks' balance sheets. When balance sheets are growing rapidly, the NPA/ asset ratio stays low, again disguising the underlying problem.
The rapid expansion in credit as a percentage of GDP, however, is unlikely to leave Chinese banks unsinged. As Fitch points out correctly, this will ultimately require sovereign bail-outs and an increase in public debt.
China's high leverage coincides with signs that the chances of growth slowing down sharply are rising. Martin Wolf quotes a Chinese agency as forecasting a slowing down of growth to 6.5% between 2018 and 2022, compared to growth of 10% from 2000 to 2010.This again points to a rise in NPAs in banks. The big question is whether the transition to slower growth will be smooth or disorderly.
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