S&P Global Ratings has downgraded China sovereign debt from A+ to AA-, following through on a warning issued earlier in the year after the country failed in an endeavor to ‘de-risk’ the country by reigning in its debt-fueled growth.
“Despite the fact that the government has shown greater resolve to implement the deleveraging policy, we continue to see overall credit in the corporate sector to stay at a 9 percent point”, Kim Eng Tan, an S&P senior director of sovereign ratings, said in a conference call to discuss the one-notch downgrade to A+ from AA-.
China’s new bank lending and total social financing (TSF) – a broad indicator of credit and liquidity, will set record highs again in 2017 following record lending of 12.65 trillion yuan ($1.84 trillion USD) – roughly the size of Italy’s economy. TSF also hit a new record at 17.8 trillion yuan ($2.7 trillion USD).
According to Kim Eng Tan, senior director of sovereign ratings at S&P, China has allowed lending to grow unchecked while at the same time neglecting to deleverage and de-risk its existing debt structures.
“We’ve now come to the conclusion that while we do expect some deleveraging in the next few years, this deleveraging is likely to be much more gradual than we thought could have been the case early this year,” Tan said, adding that rising bank lending “was the key metric that we look at…and we believe while this growth of aggregate debt financing could come down somewhat over the next few years, it’s not likely to come down very sharply.”
China scoffed at the S&P downgrade, calling it a ‘wrong decision’ that ignores China’s growth and treats them like children.
The government is fully capable of maintaining financial stability if it remains prudent on lending, strengthens supervision, and controls credit risk, the Ministry of Finance said in a statement Friday, a day after S&P cut China’s sovereign rating for the first time since 1999. The decision is “perplexing” because the economy is on a solid footing, the ministry said.
There are many indicators signaling that the bursting of the China credit bubble is imminent, which we also enumerate. The bursting of the China credit bubble poses tremendous risk of global contagion because it coincides with record valuations for equities, real estate, and risky credit around the world.
We believe this has been a centrally planned misallocation of capital into white elephant, unproductive fixed-asset infrastructure projects that on balance will likely not ever generate sufficient return on investment to justify their cost. The penalty will come from China’s future economic growth.
In our analysis, the Chinese economy today is a classic Ponzi finance regime as described by Minsky and has been so in an egregious way since 2008. At the center of China’s credit bubble is its massive and opaque financial sector. The China Banking Regulatory Commission reports that the Chinese banking system had USD 35 trillion in on-balance-sheet banking assets through the first quarter of 2017. This is an incredible more-than-fourfold bank-credit expansion since 2008 as we show in the chart below. As a result, based on the ratio of on-balance-sheet banking assets to GDP, China’s banking bubble today is more than three times larger than the US banking bubble prior to the global financial crisis!
Just as alarming as China’s on-balance-sheet banking assets are China’s shadow banking assets. The British newspaper, The Daily Telegraph, recently broke a story based on an apparent leak of the People’s Bank of China’s 2017 Annual Financial Stability Report completed in June. The PBOC report allegedly showed that off-balance sheet banking assets in China have risen to somewhere between USD 30 and 40 trillion recently. These figures have yet to be confirmed or denied because the actual PBOC report has apparently been concealed by the PBOC and the IMF. Including both on-balance sheet and shadow bank assets shown below, the Telegraph story claims that “Chinese banks have built up exposure to assets equal to 650% of GDP”. The amount of shadow banking assets in China had been more widely recognized before the PBOC report to be only USD 9 trillion. If the amount that China’s off-balance sheet banking assets have risen to even half as much as the Telegraph reported – see the chart below (about USD 37 trillion is what it shows) – China would have recently had a shadow-banking gap that is even more concerning than the credit-to-GDP gap flagged by the BIS.