1 Analyzing Moody’s outlook downgrade of China’s credit rating and weakening CCP propaganda on the economy
Moody’s downgrades China’s sovereign credit rating
On Dec. 5, Moody’s Investors Service changed its outlook on China’s credit rating from stable to negative.
Moody’s explained that there was rising evidence that the government and state companies would provide financial support to financially troubled local governments and state-owned enterprises, “posing broad downside risks to China’s fiscal, economic and institutional strength.” The rating agency added that the outlook revision also reflects the “increased risks related to structurally and persistently lower medium-term economic growth and the ongoing downsizing of the property sector.” Moody’s added that structural factors like weak demographics will see economic growth decline to 3.5 percent by 2030.
China’s debt rating remains at A1, or four levels before the triple-A top grade. Previously, about a third of issuers have been downgraded within 18 months of being assigned a negative rating outlook.
Reuters reported that local government debt reached 92 trillion yuan, or 76 percent of China’s economic output in 2022, citing the latest data from the International Monetary Fund. Reuters also cited Goldman Sachs data as showing that capital outflows from China reached $75 billion in September, the biggest monthly outflows since 2016.
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The PRC finance ministry said soon after Moody’s statement that it was “disappointed with the decision.”
The ministry added, “China’s macroeconomy continues to recover and high-quality development is steadily advancing. It is unnecessary for Moody’s to worry about China’s economic growth prospects and fiscal sustainability.”
The ministry also said China’s “long-term positive fundamentals have not changed, and it will remain an important engine for global economic growth in the future.”
The ministry further said that the impact of the real estate downturn on local fiscal budgets was “controllable and structural.” The ministry added that the PRC authorities can help local governments through payment transfers from the central government, strengthening the coordination of funds (i.e. more tightly control how local funds are spent and cut down unnecessary expenditures), and improving the local tax system.
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Reuters cited analysts as saying that a downgrade of China’s A1 rating is not likely to spur forced selling by global funds because it is high enough in the “investment-grade” territory.
Ken Cheung, chief Asian FX strategist at Mizuho Bank in Hong Kong, said, “For now the markets are more concerned with the property crisis and weak growth, rather than the immediate sovereign debt risk.”
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Moody’s cutting its outlook on China’s sovereign credit rating appeared to spark a stock selloff on Dec. 5:
- The Shanghai Composite Index lost 1.67 percent, trading below the psychologically important level of 3,000 points.
- The Shenzhen Component Index fell by 1.97 percent.
- The blue-chip index CSI 300 declined 1.9 percent.
- The ChiNext Index fell by 1.98 percent.
- The MSCI China Index lost 2.3 percent.
- Overseas investors sold a net 7.5 billion yuan of mainland shares via the Hong Kong Stock Connect, the most since Oct. 19.
CCP propaganda on the economy and banks unwilling to issue loans
Dec. 5
1. State mouthpiece Xinhua published interviews with Industrial and Commercial Bank of China chairman and Party secretary Chen Siqing and Agricultural Bank of China chairman and Party secretary Gu Shu. In their respective interviews, Chen and Gu rehashed topics discussed at the Central Financial Work Conference on preventing and defusing financial risks and the need for financial institutions to serve the real economy.
The titles of the interviews are:
- Chen Siqing: “Authoritative Interview | Helping to Build a Strong Financial Country, Preventing and Defusing Financial Risks” (權威訪談|協助金融強國建設 防範化解金融風險).
- Gu Shu: “Serving the Real Economy Well, Do Well the Five Big Articles” (權威訪談|當好服務實體經濟主力 全力做好五篇大文章). The “five big articles” are technology financing, green financing, financial inclusion, pension financing, and digital financing.
Mainland media promoted the interviews with the headline, “Breaking News! Xinhua Interviews ICBC Chairman Chen Siqing and AgBank Chairman Gu Shu” (重磅! 新華社專訪工行董事長陳四清、農行董事長谷澍).
2. Mainland media Jiemin News reported that the six major state-owned banks, as well as some joint-stock banks and city commercial banks, are maintaining close communications with real estate companies through talks or visits.
Jiemin News reported that industry insiders believe that discussions and dialogue between the banks and real estate firms will help improve the financing difficulties of non-SOEs, a common problem in the industry. However, some bankers told Jiemian News that the banks will still pay attention to risk controls and will not blindly lower credit conditions during actual business operations.
A banking insider said, “We applied for a number of credit lines with the head office and branches [of banks], and these were all approved. However, we didn’t loan out a single cent in the end.”
Jiemian News noted that the PRC the financial regulatory authorities proposed the so-called “three no lower than” (三個不低於) at a seminar for financial institutions on Nov. 17.
Real estate sales
Dec. 4
China Index Academy published data showing that the accumulated sales of China’s 100 largest real estate developers was 5.7379 trillion yuan from January to November 2023, a year-on-year decrease of 14.7 percent and a decline of 1.6 percent from the period of January to October 2023 (13.1 percent). Sales of the top 100 developers in November fell by 29.2 percent from a year ago and 0.6 percent from the previous month.
China Index Academy data also showed just 16 real estate companies with sales exceeding 100 billion yuan in the January-November 2023 period, or three fewer than over the same period in 2022. Also, there were 108 real estate firms with sales exceeding 10 billion yuan in the January-November 2023 period, or 10 fewer than over the same period last year.
Our take
1. Moody’s downgrading its outlook on China’s sovereign credit rating reflects the growing pessimism of foreigners towards China’s economic prospects that we have been observing. Foreign financial institutions also appear to be particularly pessimistic about the CCP’s ability to resolve the regime’s debt and property sector crises.
First, Moody’s explanation that its credit rating revision reflects the “increased risks related to structurally and persistently lower medium-term economic growth and the ongoing downsizing of the property sector” is evident from the PRC authorities’ lackluster policies so far in rescuing the real estate sector and from public data. The real estate sector accounts for nearly 40 percent of bank loans, more than 70 percent of the wealth of Chinese citizens, and 37 percent of local government land transfer revenue in 2022. Therefore, the downsizing of the property sector would inevitably affect China’s economic growth potential over the medium and perhaps even near term.
Beijing’s measures to rescue the real estate sector this year have been ineffective and the property debt crisis is spreading to other parts of the financial system. The Jiemin News piece about banks being reluctant to issue loans despite the PRC authorities’ proposed “three no lower than” policy to facilitate lending suggests that financial institutions in China are afraid of adding to their risks under the current circumstances. For instance, the real estate crisis means that most private enterprises with financing difficulties can no longer offer good assets as collateral. Financial institutions also do not want the risks of lending to real estate companies when the PRC authorities have not clarified who will take the final responsibility for their “three no lower than” measure.
Second, the deterioration of the real estate sector appears to be accelerating. Property prices in first-tier cities have been falling sharply in recent weeks as homeowners look to get rid of their “negative equity” with the market price of some properties dropping below the homeowners’ unpaid mortgage principal. Advertisements are cropping up online as homeowners in Beijing, Yanjiao, Shenzhen, Guangzhou, and Shanghai who cannot afford mortgage payments look to sell their property and recoup losses.
For example, an advertisement posted on Dec. 3 to “buy a house and get a free down payment” in Shanghai’s Baoshan District listed a property that was bought in 2020 for 2.65 million yuan. The homeowner has to finance a down payment of 930,000 yuan, 1.72 million yuan in loans, and 300,000 yuan in renovation fees for a total monthly payment of 12,900 yuan. The homeowner wanted to sell off the property because they were concerned about their personal credit score being affected since they could not afford the monthly payment after receiving a salary cut. The homeowner added in the advertisement that they were willing to transfer the property directly to someone willing to take on the monthly loan payments and was willing to pay a 2 percent commission to anyone who could help them close the deal.
As if the real estate situation were not bad enough, local government debt is becoming a critical issue for the regime. The Wall Street Journal reported on Dec. 5 that the total outstanding off-balance-sheet government debt in China is around $7 trillion to $11 trillion per the estimate of the IMF and Wall Street banks. This debt includes corporate bonds issued by thousands of local government financing vehicles. The Journal also reported economists as saying that a sizable chunk of the hidden debt, which is estimated to range from $400 billion to over $800 billion, is “particularly problematic and at high risk of default.” Yao Yu, founder of independent Chinese credit research firm YY Rating, told the Journal that “once a local-government financing vehicle defaults, the situation can easily get out of hand.”
The Journal cited data from Wind as showing that LGFV bonds make up close to half of China’s domestic corporate bond market, and noted that “defaults could choke off funding for other borrowers if many investors and bond buyers back away.” The Journal also cited a recent UBS report saying that the total exposure of Chinese banks to LGFVs at the end of 2022 was equivalent to about $6.9 trillion, or accounting for about 13 percent of the banking sector’s total assets.
Finally, Moody’s estimate of the economic decline that China could see resulting from weak demographics could prove overly optimistic if there was a huge drop in China’s population during the three pandemic years. Beijing’s failure to gauge the demographic changes and make policy adjustments will likely worsen the economic situation. The PRC authorities are currently still trying to claim that “all’s well” with the property sector crisis. Speaking at a financial conference in Hong Kong on Nov. 28, People’s Bank of China governor Pan Gongsheng cited an S&P report as saying that “both market sentiment and prices in China’s property market are starting to normalize” and the Chinese property market “appears to have bottomed out,” according to official media. Without properly recognizing the seriousness of China’s demographic and real estate problems, Beijing will bring to China an economic future that is much worse than that anticipated by Moody’s.
2. The PRC authorities’ response to Moody’s downgrading its outlook on China’s sovereign credit rating and other propaganda singing praises of the Chinese economy come across as weak and unconvincing. For instance, the PRC finance ministry’s description of Moody’s assessment as “unnecessary” pales in comparison to official criticism of Moody’s for making a similar outlook downgrade in March 2016. At the time, PRC officials and state media slammed Moody’s for having “no foresight” and for “maliciously badmouthing” China. The PRC authorities’ relatively tame pushback against Moody’s over the recent outlook change suggests that Beijing does not want to be overly aggressive to a foreign rating agency and frighten away foreign investors even more; if so, this behavior is an indirect admission by the authorities that Moody’s assessment of China’s economic weakness is more or less accurate.
Meanwhile, Xinhua’s release of interviews with the head of the ICBC and AgBank on the same day as Moody’s outlook downgrade is likely an attempt to create the illusion that China’s economic prospects are improving. The propaganda, however, will likely have little effect on boosting the economy and lacks practical operability. We also previously analyzed how the CCP has been unable to extricate itself from a bureaucratic quagmire in implementing measures meant to support the private economy. Despite having introduced 108 policies to back the private economy thus far in 2023, the joint notice by eight PRC organs and ministries on strengthening financial support measures to aid the development and growth of the private economy notes that the “next step” is guiding financial institutions in promptly implementing the requirements of the notice and in formulating specific implementation rules, which suggests that there is still a gap between the rolling out of measures and their enactment.
2 Paper on PRC near-space force hints at Xi’s concerns with PLA operations
Researchers from the PRC’s National University of Defence Technology noted in a paper submitted to the 11th China Command and Control Conference in October 2023 that the CCP regime has created a near-space command equipped with a professional hypersonic weapons force that reports directly to the regime’s top military command.
Notable points in the paper, which became publicly available on major PRC academic databases around late November, include:
- The researchers wrote that the near-space combat force “is in the process of rapid development.” However, “the establishment of relevant units is not yet mature,” “combat operations have not been standardized,” and the “understanding of near-space combat command needs to be deepened.”
- The researchers wrote that “it is necessary to adjust the hierarchy of command and control powers, selection of command methods, implementation of executive orders, and support for command communication.”
- The researchers wrote that the near-space command would be equipped to attack critical targets as well as conduct high-altitude surveillance around the world through automated drones and spy balloons.
- Because “the near-space force operates in a special battlefield” and “actions carried out in sensitive areas or over the territory of other countries may trigger political or diplomatic reactions,” the researchers wrote that it is necessary to “shift the decision-making power upwards,” including over daily combat readiness operations for the near-space command’s stratospheric airships, long-endurance unmanned aerial vehicles, and other platforms. “The highest military command can approve the scale of use, activity areas, and method of use to avoid causing political and diplomatic nuisance,” the researchers noted.
- The researchers wrote that senior officials can “very likely issue some tactical orders that are not within the scope of their responsibilities, causing lower-level officials or combatants (i.e. weapon equipment operators) to be unsure of what to do, and this can negatively affect their actions.” Therefore, the near-space command’s officers need a “deep understanding” of global strategic situations, national policies, and strategic guidelines.
Backdrop
In early February 2023, a PRC surveillance balloon floated across the United States continent before it was shot down by a U.S. fighter jet over the Atlantic Ocean off the South Carolina coast. The PRC spy balloon incident worsened Sino-U.S. relations and sparked concerns in the international community about PRC spy operations and aggression.
Our take
The paper by researchers from the National University of Defence Technology on the PRC’s establishment of a near-space force indirectly affirms our earlier assessment of Xi Jinping’s insecurities about his control over the military and the Party, as well as reporting in Western media about how Xi was furious with senior People’s Liberation Army military generals for keeping him in the dark about the PRC spy balloon until it had flown over the United States. Xi’s lack of awareness about the balloon is akin to Hu Jintao being apparently caught off-guard by the PLA’s testing of the J-20 stealth fighter before then-U.S. Defense Secretary Robert Gates’ trip to Beijing in January 2011.
Xi’s concerns with military control and the need to avoid unnecessary escalation during the current period of heightened geopolitical tensions are clear from the paper’s call to “shift the decision-making power upwards” over daily combat readiness operations for the near-space command’s stratospheric airships, long-endurance unmanned aerial vehicles, and other platforms so that the “highest military command can approve the scale of use, activity areas, and method of use to avoid causing political and diplomatic nuisance.”
Meanwhile, Xi wants senior officials to have a “deep understanding” of global strategic situations, national policies, and strategic guidelines so that they can keep their subordinates in check without Beijing having to constantly look over their shoulders and see that the PLA does not provoke unwanted international incidents like the one involving the PRC spy balloon.
The clarifications and emphasis in the paper about command matters indicate that Xi has not fully consolidated his control over the PLA despite having enacted sweeping military reforms in 2016. Xi’s insecurities about the PLA is likely one of the decisive factors behind why Xi told President Joe Biden that he does not have plans to invade Taiwan; arming the troops for an invasion when command issues remain unresolved is a recipe for disaster for Xi.
We are pessimistic about Xi Jinping’s ability to resolve his military command issues or avoid incidents like the PRC spy balloon episode as long as he clings on to the Party and is subject to the serious systemic deficiencies of the CCP authoritarian dictatorship.
