As worries mount about unsustainable levels of debt in the Chinese economy, a major ratings firm on Tuesday announced that it has changed its outlook for China's sovereign debt to negative.
Moody's Investors Service warned that high levels of debt among regional and local governments, many of which are struggling to remain current on their payments, is expected to force the Chinese government to step in with financial assistance.
At a time when the Chinese economy is stumbling and growth rates are lower than expected, Moody's warned that this added burden could put fiscal pressure on the government.
"The change to a negative outlook reflects rising evidence that financial support will be provided by the government and wider public sector to financially stressed regional and local governments and State-Owned Enterprises, posing broad downside risks to China's fiscal, economic and institutional strength," the agency said in a press release.
"The outlook change also reflects the increased risks related to structurally and persistently lower medium-term economic growth and the ongoing downsizing of the property sector."
Current rating unchanged
In its announcement, Moody's affirmed that its current rating of China remains A1, several notches below the top level of Aaa, but still in the middle of what the agency considers "investment grade" debt. The United States is rated Aa1 by Moody's, one step below the top rating.
The Chinese Finance Ministry said in a statement that it was "disappointed" by the change, adding, "Moody's concerns about China's economic growth prospects, fiscal sustainability and other aspects are unnecessary."
The other major ratings agencies, Standard & Poor's and Fitch, both currently rate China's debt in the middle of the investment grade tier, with a stable outlook.
Long-term crisis
For years, China has grappled with the indebtedness of provincial and local governments. In past decades, those entities have been charged with powering the country's economic growth and have done so mostly by investing in infrastructure projects.
Provincial and local governments took on debt to finance those projects, both directly and through entities known as local government financing vehicles, or LGFVs. These were theoretically distinct from governments but carried an implicit guarantee of government backing.
Those investments did power strong economic growth at first. But many were misdirected, either to projects with little long-term economic benefit or to favored companies that failed to deliver on their promises.
Provincial and local governments have for years financed their borrowing with land sales, but a number of economic factors have combined to drive China's real estate sector into a protracted slump, making it increasingly difficult for them to service their debts.
Last month in a public forum, Pan Gongsheng, governor of the People's Bank of China, said the central bank is prepared to step in to provide provincial and local governments with assistance.
"When it's necessary, the People's Bank of China will provide emergency liquidity support to regions with a relatively heavy debt burden," he said.
No big surprise
Economist Brad W. Setser, a senior fellow at the Council on Foreign Relations, said there is little in the Moody's report that will be news to anyone who has followed the Chinese economy closely.
"I think everybody knows that China has a combination of some real fiscal strength — the central government's debt-to-GDP ratio is exceptionally low — and some real fiscal weaknesses," he told VOA.
The trouble, he said, is that while the central government in Beijing collects most government revenue, it is the provincial and local authorities that have to service the ballooning debts.
"China's government sector writ large has a significant amount of debt," Setser said. "It's just a question, really, of whether the strong balance sheet at the center can offset some of the weakness in the periphery."
'Already stepping out'
While the Moody's report warns that the Chinese government will need to intervene with fiscal support for provincial and local governments, Tianlei Huang, a research fellow and China Program coordinator at the Peterson Institute for International Economics, points out that Beijing is already doing so.
"We see the central government has been giving an increasing amount of intergovernmental transfers to local governments in recent years, and just two months ago announced that they will issue some additional treasury bonds, and that the entire proceeds will go to local government directly," he said. "So in a sense, the central government is already stepping out to help local governments."
Immediate impact limited
Experts told VOA that the impact of the change in Moody's outlook would likely be limited, even if it were to be followed up by a future downgrade.
"Some of the usual implosive implications of credit downgrades are absent in the Chinese context, since China's financial markets and global markets are carefully regulated by the government," Peter Petri, a professor of international finance at the Brandeis International Business School, said in an email exchange. "A foreign run on Chinese bonds or a rapid exit of capital to Western markets is just not in the cards."
However, Petri said he is not convinced the government is willing to take the kinds of steps that would solve the problem in the long term.
Going forward, rather than announce major changes, he said, Beijing may decide to take a series of smaller steps to build confidence in the economy, such as setting attainable growth targets, offering some fiscal stimulus, and providing support for local governments and struggling companies.
"Such fine tuning won't solve the structural problem identified by outside economists — the need to replace infrastructure and real estate-based growth with a new model. The most plausible alternative, which may be anathema to [Chinese President Xi Jinping], is market-oriented growth," Petri wrote in the email.
"So far, no alternative has appeared — not common prosperity or technological self-sufficiency, which are announced national objectives, but have yet to be plausibly connected to economic growth."
