China’s rising debt prompts Moody’s to cut credit outlook

In another blow to China’s economy, credit rating agency Moody’s said on Tuesday it had issued a negative outlook for the Chinese government’s fiscal health.

Moody’s expressed concern about the potential costs to the national government of bailing out debt-ridden regional and local governments and state-owned businesses. Moody’s, which previously viewed China’s financials as stable, warned that the country’s economy is settling into slower growth as its massive property sector begins to shrink.

China’s finance ministry immediately pushed back, saying the Chinese economy was resilient and local government budgets could withstand revenue losses from the country’s real estate slump.

At the same time, Moody’s reaffirmed its overall A1 credit rating for the Chinese government, which is in the middle of what is generally considered “investment grade,” or low risk. A negative outlook on a credit rating does not necessarily mean a downgrade is imminent, but serves as a warning that the existing rating may not be sustainable.

The downgrade of the debt outlook nonetheless marks a major milestone for China’s economy.

Until recently, China had unlimited cash to spend on the world’s largest bullet train network, a vast military buildup, subsidies to manufacturers, and extensive overseas construction projects.

China today faces increasingly tight budget constraints, fueled mainly by a steep decline in the real estate sector. Construction of apartments, factories, office towers and other projects is the country’s largest industry, accounting for 25 percent of economic output. Apartments are a major investment for most families, accounting for three-fifths or more of their savings.

While borrowing by China’s national government has been limited, local and regional governments and state-owned enterprises have borrowed heavily over the past 15 years. The money local governments have received from lenders has created high economic growth, but many of them are now in serious trouble.

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For China, the change in credit outlook will have little direct effect on its finances. Unlike many other countries, China relies very little on external debt. The national government mainly sells bonds to the country’s state-owned banks. The country’s regional and local governments and state-owned enterprises also sell bonds to them.

Beijing emphasized China’s economic leadership during the global financial crisis in 2008 and 2009, when the U.S. housing market suffered a sharp decline. Now China faces a similar and potentially larger housing slump. Dozens of major real estate developers are bankrupt and unable to complete hundreds of thousands of apartments for which they have already accepted large deposits.

Developers have left small businesses and other contractors with hundreds of billions of dollars in late bills, triggering a cascade of payment problems. Apart from a few state-owned businesses, developers have largely stopped buying land for future housing construction.

Land sales were a major source of income for local governments. Many of them are now facing a crisis as income from these sales has plummeted. In its report on Tuesday, Moody’s said the national government should help these governments cope.

Difficulties in the real estate sector have dragged down economic growth, contributed to high youth unemployment and discouraged many families from spending money.

“The structural change also reflects heightened risks related to structural and persistently low medium-term economic growth and continued contraction of the property sector,” Moody’s said.

China’s Ministry of Finance rejected Moody’s arguments. While local government revenue from land sales has fallen, those same governments are spending less to compensate residents whose homes have been bulldozed to make way for new buildings. The ministry also stressed that China’s economy still has considerable momentum.

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China is not alone in receiving Moody’s concerns. The agency last month cut its credit outlook for the US to negative, while reaffirming the country’s top AAA rating.

Compared to the size of its economy, China’s overall debt is now higher than that of the United States.

China’s credit rating was downgraded by Moody’s and S&P Global Ratings in 2017. More recently, S&P has expressed less concern about China’s economy than Moody’s. Hours before Moody’s announcement on Tuesday, S&P said it hoped China could avoid a reflection of Japan’s “lost decade” of weak economic activity following its housing collapse in the early 1990s.

Fitch Ratings told Bloomberg Television earlier this year that it might revise China’s sovereign debt rating, but recently affirmed that rating with a stable outlook.

China’s economy has endured a bumpy ride this year from nearly three years of strict “zero Covid” measures, including the world’s longest and strictest municipal lockdowns.

The economy grew at an annual pace of 5.3 percent from July to September. A debt-fueled increase in manufacturing investment and very strong spending in restaurants and hotels offset that Decline in apartment construction.

Data for October and November are mixed. Investment is strong in new factories that make electric cars and other advanced products. But the arrival of cold weather has brought a wave of respiratory illnesses across much of China, initially among children and adults. This has left many restaurants and other service sector spaces vacant.

Moody’s said the vast size of the Chinese economy, the world’s second-largest after the United States, gave it considerable capacity to absorb shocks. The finance ministry agreed, “The long-term positive fundamentals have not changed and will remain a key engine for global economic growth in the future.”

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