China Credit Outlook Cut to Negative From Stable by Moody's

[PARIKRAMA]

Thanks for the summary. I dont have access to these reports anymore.

When I look at a financial statements, contingent liabilities are the most interesting items to me as they are off balance sheet items. These liabilities in themselves aren't bad provided the resources are present to take the hit if they go sideways.

The other factor which I feel is often over-looked are the specifics of asset quality specially by rating agencies. China in this regard is a big question mark for me. They have been investing quite heavily in emerging markets all over the world and some of these investment are guided purely by geo-politics rather than financial risk and viability. While on paper these investments may be credit worthy, there is a lot of fudging of actuals and off the book quid pro quo. To be clear all countries indulge in this practice but not on the scale China does. The only other peer in terms of total investment is Japan and Japanese investments are financially very sound and clean. Germans and others in the list have very different set of criteria and most of the investment is on corporate level so not worth discussing.

Contingent liabilities is a big topic of interest no doubt.. The more you dwell into it, the more you will be fascinated by risks and underlying assets relationship aspect and how every one handles such risks... of course not every one is prudent nor every decision is always correct. But in general the risks of today can at least be partially forecasted better then say 2-3 decades back..

Oh yes, my friend the investments in emerging markets or say in African continent to many private sector companies of China doing projects via a loan or via a direct FDI route all are pointers to a much deeper risk contagion.. The EM itself are risky and these countries cannot sustain much of the issues and thus their viability+financial risk is always way too high..

An example I quote is this from the article
The bulk of China’s FDI has been concentrated in a relatively few countries. Between 2003 and 2007, five countries—Nigeria, South Africa, Sudan, Algeria and Zambia—accounted for more than 70 percent of China’s FDI. While these countries remain important recipients, others such as Guinea, Ghana, Democratic Republic of the Congo and Ethiopia have joined the list in recent years. In 2010, Ethiopia had, for example, 580 registered Chinese companies operating with estimated investment capital of $2.2 billion. Some of this new FDI is coming thru Chinese special economic and trade cooperation zones. China is working with African counterparts to establish seven of them: two each in Zambia and Nigeria and one in Mauritius, Egypt and Ethiopia.

Source: China’s Investments in Africa | Africa Up Close


Now have a look at few data pointers

These 2 slides are from D&B

This one is from Euler Hermes

So lets check here

1. Nigeria - Sensitive Risk
2. South Africa - Medium Risk
3. Sudan - High Risk
4. Algeria - Medium Risk
5. Zambia - Sensitive Risk
6. Guinea - High Risk
7. Ghana - Medium Risk
8. Democratic Republic of the Congo - Sensitive Risk
9. Ethiopia - Sensitive Risk
10. Mauritius - Low Risk
11. Egypt. - High Risk

Additionally lets see these African countries who export to China a lot from first figure by D&B

• Sierra Leone - High Risk
• Angola - Sensitive Risk
• Zimbabwe - High Risk
• Gabon - Sensitive Risk

So you see the underlying financial support via FDI or via State Owned Enterprise funding companies doing work in these countries all face mostly sensitive to high risk.. Thus, there is a high chance any fallout bcz of issues in these individual investments and extended credit can lead to issues owing to not so good underlying asset quality as well as nations credibility.

A simple comparison here for the world by EH is like this
Americas

Europe and Middle East

Asia and Australia and everybody

These slides taken from Euler Hermes.


If you see the majority of the high risk and sensitive risk are the places which needs external support in the form of FDI and investments by China's pvt sector companies. China has done that no doubt but looking at today the risk aspect has increased by a good margin..

I am not saying its not manageable but risk is biased towards more problems than less problems envisioned when these investments were made.

@jhungary @Nihonjin1051 @AUSTERLITZ

 

[ito]

Contingent liabilities is a big topic of interest no doubt.. The more you dwell into it, the more you will be fascinated by risks and underlying assets relationship aspect and how every one handles such risks... of course not every one is prudent nor every decision is always correct. But in general the risks of today can at least be partially forecasted better then say 2-3 decades back..

There is nothing wrong in using contingent liabilities. In fact project financing is one such contingent liabilities that can help bring the risk of the whole entity down. The problem arise when people twist accounting rules to show healthy net worth on Balance sheet use contingent liabilities to hide toxic assets, law suites, liabilities whose value cannot be valued with high degree of probability, or unfunded reserves. I guess Chinese banks have a very high degree of non performing loans that Chinese government use contingent liabilities to 'hide' them.

 

[jhungary]

What Moody said is this

Main Rating
The key drivers of the outlook revision are:

1. The ongoing and prospective weakening of fiscal metrics, as reflected in rising government debt and in large and rising contingent liabilities on the government balance sheet.

2. A continuing fall in reserve buffers due to capital outflows, which highlight policy, currency and growth risks.

3. Uncertainty about the authorities' capacity to implement reforms -- given the scale of reform challenges -- to address imbalances in the economy.

At the same time, China's fiscal and foreign exchange reserve buffers remain sizeable, giving the authorities time to implement some reforms and gradually address imbalances in the economy. This underpins the decision to affirm China's Aa3 rating.

RATIONALE FOR ASSIGNING A NEGATIVE OUTLOOK

FIRST DRIVER -- WEAKENING FISCAL METRICS AND SIZEABLE CONTINGENT LIABILITIES

The first driver of the negative outlook on China's rating relates to the government's fiscal strength which has weakened and which we expect to diminish further, albeit from very high levels.

The government's balance sheet is exposed to contingent liabilities through regional and local governments, policy banks and state-owned enterprises (SOEs). The ongoing increase in leverage across the economy and financial system and the stress in the SOE sector imply a rising probability that some of the contingent liabilities will crystallize on the government's balance sheet. In addition, we believe that continuing growth in contingent liabilities -- along with stated government objectives to introduce more market discipline -- suggests that support from the government and the banking system will increasingly be prioritized, based on the relative importance of each entity for the implementation of strategic national policy goals.

While not our base case scenario, the government's fiscal strength would be exposed to additional weakening if underlying growth, excluding policy-supported economic activity, remained weak. In such an environment, the liabilities of policy banks would likely increase to fund government-sponsored investment, while the leverage of SOEs -- already under stress -- would rise further.

We do not expect all or even a significant proportion of contingent liabilities to crystallize on the government's balance sheet in the short term. However, their existence and increase in size reflect economic imbalances. In particular, high and rising SOE leverage raises the risk of either a sharp slowdown in economic growth, as debt servicing constrains other spending, or a marked deterioration of bank asset quality. Either of these developments could ultimately result in higher government debt and additional downward pressure on the government's credit profile.

In addition, government debt has risen markedly, to 40.6% of GDP at the end of 2015, according to our estimates, from 32.5% in 2012. We expect a further increase to 43.0% by 2017, consistent with an accommodative fiscal stance that will likely involve higher government spending and possible reductions in the overall tax burden.

At the same time, we expect debt affordability to remain high as large domestic savings will continue to fund government debt.

SECOND DRIVER -- ERODING EXTERNAL STRENGTH

The second driver relates to China's external vulnerability. China's foreign exchange reserves have fallen markedly over the last 18 months, to $3.2 trillion in January 2016, $762 billion below their peak in June 2014.

At the same time, reserves remain ample, particularly in relation to the size of China's external debt. However, their decline highlights the possibility that pressure on the exchange rate and weakening confidence in the ability of the authorities to maintain economic growth and implement reforms could fuel further capital outflows. In particular, a fall in reserves -- corresponding to sustained deposit outflows -- could raise pressure on the deposit-funded banking sector.

Measures to address falling foreign exchange reserves and downward pressure on the renminbi have negative implications for the economy and financial sector.

• First, a tightening of capital controls in response to sustained outflows would damage the credibility of the authorities' commitment to liberalizing the capital account, an essential element of financial sector reform.
• Second, allowing reserves to fall to preserve the value of the currency -- when pressures exist -- would tighten liquidity conditions in China at a time when parts of the economy are slowing sharply and when the debt-servicing capability of some corporates is impaired.
• Third, preserving foreign exchange reserves and allowing a sharp depreciation of the currency would likely fuel further capital outflows.

THIRD DRIVER -- RISKS OF A LOSS IN POLICY CREDIBILITY AND EFFICIENCY

The third driver concerns institutional strength. China's institutions are being tested by the challenges stemming from the multiple policy objectives of maintaining economic growth, implementing reform, and mitigating market volatility. Fiscal and monetary policy support to achieve the government's economic growth target of 6.5% may slow planned reforms, including those related to SOEs.

Incomplete implementation or partial reversals of some reforms risk undermining the credibility of policymakers. Interventions in the equity and foreign exchange markets over the past year suggest that ensuring financial and economic stability is also an objective, but there is considerably uncertainty about policy priorities.

Without credible and efficient reforms, China's GDP growth would slow more markedly as a high debt burden dampens business investment and demographics turn increasingly unfavourable. Government debt would increase more sharply than we currently expect. These developments would likely fuel further capital outflows.


RATIONALE FOR AFFIRMING CHINA'S Aa3 RATING

The very large size of China's economy contributes to its credit strength. Moreover, although GDP growth is slowing, it will remain markedly higher than most of China's rating peers. The size of the buffers available to face current fiscal and capital outflow challenges allows for a gradual implementation of reform and therefore supports an affirmation of the rating at Aa3. These buffers include a relatively moderate level of government debt, which is financed at low cost, and high domestic savings and still substantial foreign exchange reserves.

We expect a gradual economic slowdown, made possible by the capacity and willingness of the authorities to support growth. Moreover, although contingent liabilities are large, they do not pose an imminent risk to the government's balance sheet. In a largely closed financial system, buffer erosion would most likely be gradual, providing time to address key areas of reform.


WHAT COULD CHANGE THE RATING UP/DOWN

Moody's could revise the rating outlook to stable if we concluded that government policy was likely to succeed in balancing competing priorities and thereby arrest the deterioration in China's fiscal metrics and reduce contingent liabilities for the sovereign most likely through effective restructuring of SOEs in overcapacity sectors.

Moreover, a moderation in capital outflows due to improved confidence in the economy and policies as well as advancement of reforms -- in particular in the SOE and financial sectors, including some further opening of the capital account -- would be consistent with returning the outlook to stable.


Conversely, Moody's could downgrade the rating if we observed a slowing pace in the adoption of reforms needed to support sustainable growth and to protect the government's balance sheet. Tangibly, this could happen if debt metrics weaken, contingent liabilities increase, or progress on SOE reform stalls. Sustained capital outflows or a marked tightening in capital controls without tangible progress on reform implementation would also be consistent with a downgrade of the rating.


COUNTRY CEILINGS

• China's local and foreign-currency bond and deposit ceilings remain at Aa3.
• China's short-term foreign-currency bond and bank deposit ceilings remain at Prime-1 (P-1).
• GDP per capita (PPP basis, US$): 13,224 (2014 Actual) (also known as Per Capita Income)
• Real GDP growth (% change): 7.3% (2014 Actual) (also known as GDP Growth)
• Inflation Rate (CPI, % change Dec/Dec): 1.5% (2014 Actual)
• Gen. Gov. Financial Balance/GDP: -1.8% (2014 Actual) (also known as Fiscal Balance)
• Current Account Balance/GDP: 2.1% (2014 Actual) (also known as External Balance)
• External debt/GDP: 8.6% (2014 Actual)
• Level of economic development: Very High level of economic resilience
• Default history: No default events (on bonds or loans) have been recorded since 1983.

On 29 February 2016, a rating committee was called to discuss the rating of the China, Government of.
The main points raised during the discussion were:

• The issuer's institutional strength/framework, have decreased.
• The issuer's fiscal or financial strength, including its debt profile, has decreased.
• The issuer has become more susceptible to event risks.
• Other views raised included: The issuer's economic fundamentals, including its economic strength, have not materially changed

@Shotgunner51 @Nihonjin1051 @jhungary @Spectre
Sorry i took some time as i needed to login into my office system to get the moody report. Apologies in advance as i cannot share the main report (paid subscription of my corporate entity). This is the best gist i could copy paste.


As you read and see the basis of this report versus what is in media reports by Bloomberg is a bit opposite.. The concerns are raised for defaulting debt and CDS whereas this report talks about risks whereas its clear that long term the rating is still stable at Aa3. Of course the outlook points to changing risk metrics where it sees a downgrade rating risk based on factors which it has clearly mentioned.

Sadly all these points were missed and has created a bit confusion here where focus was given on both Debt and NIIP which represents two sides of the same coin bcz i can always be surplus with my savings account and still owe a debt in credit or any other loan too in layman terms..


The negative outlook based on contingent liability crystallization risk+ decrease in Fx + slowdown in reforms are the key risk points ...

I hope with this the whole discussion could move to more fundamental issues which are being raised.

Contingent liabilities is a big topic of interest no doubt.. The more you dwell into it, the more you will be fascinated by risks and underlying assets relationship aspect and how every one handles such risks... of course not every one is prudent nor every decision is always correct. But in general the risks of today can at least be partially forecasted better then say 2-3 decades back..

Oh yes, my friend the investments in emerging markets or say in African continent to many private sector companies of China doing projects via a loan or via a direct FDI route all are pointers to a much deeper risk contagion.. The EM itself are risky and these countries cannot sustain much of the issues and thus their viability+financial risk is always way too high..

An example I quote is this from the article
The bulk of China’s FDI has been concentrated in a relatively few countries. Between 2003 and 2007, five countries—Nigeria, South Africa, Sudan, Algeria and Zambia—accounted for more than 70 percent of China’s FDI. While these countries remain important recipients, others such as Guinea, Ghana, Democratic Republic of the Congo and Ethiopia have joined the list in recent years. In 2010, Ethiopia had, for example, 580 registered Chinese companies operating with estimated investment capital of $2.2 billion. Some of this new FDI is coming thru Chinese special economic and trade cooperation zones. China is working with African counterparts to establish seven of them: two each in Zambia and Nigeria and one in Mauritius, Egypt and Ethiopia.

Source: China’s Investments in Africa | Africa Up Close


Now have a look at few data pointers
View attachment 296341

View attachment 296342

These 2 slides are from D&B

This one is from Euler Hermes
View attachment 296354

So lets check here

1. Nigeria - Sensitive Risk
2. South Africa - Medium Risk
3. Sudan - High Risk
4. Algeria - Medium Risk
5. Zambia - Sensitive Risk
6. Guinea - High Risk
7. Ghana - Medium Risk
8. Democratic Republic of the Congo - Sensitive Risk
9. Ethiopia - Sensitive Risk
10. Mauritius - Low Risk
11. Egypt. - High Risk

Additionally lets see these African countries who export to China a lot from first figure by D&B

• Sierra Leone - High Risk
• Angola - Sensitive Risk
• Zimbabwe - High Risk
• Gabon - Sensitive Risk

So you see the underlying financial support via FDI or via State Owned Enterprise funding companies doing work in these countries all face mostly sensitive to high risk.. Thus, there is a high chance any fallout bcz of issues in these individual investments and extended credit can lead to issues owing to not so good underlying asset quality as well as nations credibility.

A simple comparison here for the world by EH is like this
Americas
View attachment 296365

Europe and Middle East
View attachment 296366

Asia and Australia and everybody
View attachment 296367

These slides taken from Euler Hermes.


If you see the majority of the high risk and sensitive risk are the places which needs external support in the form of FDI and investments by China's pvt sector companies. China has done that no doubt but looking at today the risk aspect has increased by a good margin..

I am not saying its not manageable but risk is biased towards more problems than less problems envisioned when these investments were made.

@jhungary @Nihonjin1051 @AUSTERLITZ

lol, to be fair, I don't quite understand why and how I start talking about debt first, anyway.

The moody gave the Chinese outlook a negative may not be such a bad things. It highlight the instability and the reform that is urgently needed to go back to a stable investing environment.

The problem is that, while the outlook is downgraded, the risk were remained. That saying a few things.

First, the borrowing environment is not yet hostile, but the trend if going uncapped, would be disastrous. The reason behind this is China have many project right now which is on, and while there are no clear indication that those project is going to fail, it cast doubt on the expanding of Chinese economy, especially when the overall GDP growth was shrinking.

Expanding too fast is one of the hidden problem China currently facing. While the Chinese FDI are risky business as well, just like what you said, the outlook probably looking at it on the negative light, however, as Moody pointed out (and I have pointed out in previous post), China still have means to finance it own reform, simply because they have the forex and net asset to do so, but the timing is urgent, that's the reason why moody downgraded China's outlook.

China need to stop it's borrowing habit, and consolidate their financial strength and then recalibrate their investment portfolio before they have ran out of surplus to do so.

 

[vtnsx]

If it will happen, then it would have happened decades back when China was at its weakest. You can't find a better time can you?

You have to make the most foolish of claims now that China is the dominant regional power with technologies, man power, economy, space and nuclear capabilities that you can only dream of.

If it happens, I won't be the one hiding behind any walls, I would be out there laughing at the likes of you.

You South Annamese can dream on about your great saviour the US putting you guys back in power and the communist party would allow you to take back Vietnam.

You sound so dumb right now. The only thing China is good at is producing crap product to the world. Nothing in China is reliable and done right. Only the people with low standards like you would claim China tech is the best. You're so clueless on how technology works because you're nothing but an internet troll spewing garbage about your technology. Quit embarrassing yourself. I know my shit when it comes to technology because I have the education and experience working on them.

China is not the only country to have all that capabilities. LOL, it isn't even a dream to obtain those technology either. It is a dream to obtain Quantum computers though.

Quit claiming things that you aren't. It makes you look like a fool.

US is a savior? of course, lol they saved your a$$ from Russia back when you were poor and didn't have proper technology to counter Russia. US did more than just helping your country by sending factories to China and give you people jobs from the start. Bruce Lee, Jackie Chan and many other Chinese actors and actresses didn't became popular in the US without the US's assistant. But you Chinese are ungrateful people and a traitor. You will never become a superpower with your copyrighted and stolen products from the west. Keep dreaming kid. The West is authentic, you ain't.

 

[LeveragedBuyout]

@jhungary @Shotgunner51

It took me a while to read through this thread, and it looks like @PARIKRAMA already addressed most of the issues. I just wanted to add a few minor details to help bridge the gap between what the two of you are arguing about.

1) NIIP is a sub-set of a nation's balance sheet, so to rely on NIIP as a proxy for fiscal health is a mistake (see Japan).

2) NIIP uses book value for several of its components, because market valuation isn't possible or practical. Especially in China's case, where it extends loans to unworthy borrowers overseas in order to advance its OBOR initiative, the value of those "assets" is likely overstated and should be written down. Most independent analysts already believe that China's NPL ratio is vastly understated for its domestic loans--why should it be different for its foreign loans? China has a poor track record with its overseas investments.

3) NIIP as a percent of GDP is declining, therefore becoming less relevant:

(Source: All about China’s public-to-private foreign asset swap | FT Alphaville )

4) China's central government debt is low.

5) China's total debt (household, corporate, financial, local government, central government) debt is very high, especially for an emerging market. We have all seen the McKinsey study:

Everyone is piling on debt:

But China is in a league of its own:

(Source: Debt and (not much) deleveraging | McKinsey & Company )

(Source: China’s Total Debt Load Equals 282% of GDP, Raising Economic Risks - Real Time Economics - WSJ )

China's debt is not only high, it is accelerating quite fast. Hence Moody's apprehension.

6) @PARIKRAMA @Spectre and @ito wisely raised the issue of contingent liabilities. What is considered corporate debt will eventually become government debt, due to the government's implicit guarantee of SOE debt. And we all know that many SOEs must either be directly bailed out, or indirectly bailed out by pressuring the banks to roll over their NPLs to these SOEs instead of writing them off and cutting off credit. And then we must discuss bailing out the banks (i.e. financial debt now becomes government debt). But that's a discussion that belongs in the over-arching theme of China's structural reform process.

Finally, I think the two of you (@jhungary @Shotgunner51 ) have gotten lost in the weeds on your argument, and lost perspective of the bigger picture, namely: is China financially stable? The answer is yes. Moody's is not downgrading China to non-investment grade status, and it's not even downgrading China's rating. It is putting China on a negative rating watch, identifying issues that China must address in order to prevent a downgrade.

Xi Jinping has unfortunately proven to be less competent than was originally hoped when it comes to restructuring China's economy, so it's possible he will continue to avoid the hard decisions that are necessary to get China back on a firm footing. You know, the reforms he already promised to do, but has been too afraid to actually carry out (financial liberalization, opening the capital account, floating the RMB, privatizing SOEs, etc.).

If China is lucky, Xi Jinping will return the power to manage to economy to his premier, Li Keqiang, who has a much better grasp of the situation than Xi. China can still turn the situation around and set itself up for another period of robust growth while it moves beyond the middle income trap.

If China is not lucky, we may begin to see a "going Japanese" process, with no hard landing, but rather a long period of stagnation as the financial system becomes beholden to zombie companies, while China's future, its SMEs, are starved of credit.

Unfortunately, Xi will be in power well into the 2020s, so unless he suddenly gets religion (and he's not--he's moving to further consolidate CCP control over the economy, in fact), it's more difficult to be optimistic about China's reform process until he's gone.

 

[TheTruth]

@jhungary @Shotgunner51

If China is lucky, Xi Jinping will return the power to manage to economy to his premier, Li Keqiang, who has a much better grasp of the situation than Xi. China can still turn the situation around and set itself up for another period of robust growth while it moves beyond the middle income trap.

If China is not lucky, we may begin to see a "going Japanese" process, with no hard landing, but rather a long period of stagnation as the financial system becomes beholden to zombie companies, while China's future, its SMEs, are starved of credit.

Unfortunately, Xi will be in power well into the 2020s, so unless he suddenly gets religion (and he's not--he's moving to further consolidate CCP control over the economy, in fact), it's more difficult to be optimistic about China's reform process until he's gone.

1. Debt and especially total debt to GDP is nearly worthless as an indicator if you get into the details of how each are calculated.

2. Xi is dismantling a lot of the connections-based "defenses" of inefficient enterprises. You can't just go in with a sledgehammer and completely retool the economy overnight. I wonder where you are getting such up to date info on how well or poorly Xi is reforming. Can you think of any case other than Glasnost where so much has been changed in so little time?

3. China bailing its banks out would not qualify as a bail-out because all their banks are de facto part of the CPC's executive arm. They have much more power to enforce discipline and oversight than any stressed government, past or present.

I project that your recipe is for a sudden transition into a weak-government with strong corporates, as was seen in 1990s Russia. This yielded many profitable opportunities for foreign oligarchs.

 

[LeveragedBuyout]

1. Debt and especially total debt to GDP is nearly worthless as an indicator if you get into the details of how each are calculated.

Agreed. Again, analysts get lost in the details and forget the big picture. The big picture is: when Chinese corporates and the Chinese government need funds, can they raise those funds? The answer is yes. Debt/GDP, NIIP, CDS spreads, etc. are simply details, but what matters--the ability to raise funds--is beyond question. China will not face a capital shortage any time soon, just as Japan has not faced a capital shortage over the last 25 years.

2. Xi is dismantling a lot of the connections-based "defenses" of inefficient enterprises. You can't just go in with a sledgehammer and completely retool the economy overnight. I wonder where you are getting such up to date info on how well or poorly Xi is reforming. Can you think of any case other than Glasnost where so much has been changed in so little time?

My primary sources of information on the Chinese economy are Caixin (aka "biased Western media"), South China Morning Post (aka "biased Western media"), Xinhua (aka "biased Western media"), The Wall Street Journal, and the Financial Times. I have tried reading "unbiased Chinese media" sources like China People's Daily and Global Times, but it cuts too much into my Russia Today and Press TV time, and we all know that those are the gold standards in "unbiased non-Western media" sources.

Regarding how well Xi is reforming, perhaps you can present a checklist of successes that he has achieved. I have clearly been misinformed, because all I can see is the failure of the much-touted Shanghai Pilot Free Trade Zone, failure to increase the "decisive role of market forces" on the economy (deregulation, privatizing SOEs, increasing credit to SMEs, floating RMB, relaxing capital controls, non-intervention in the stock market, etc.), opening up the economy to foreign investment, etc.

I am open minded, but I will need to be convinced. Other than some marginal adjustments like the one-child policy, what reforms have been enacted that move you to imply that China has achieved reform under Xi at such a pace that there is no comparable example since "Glasnost where so much has been changed in so little time"? China achieved that pace of reforms in the 1990s and early 2000s, clearly, but I don't see such a scale of reform under Xi. What am I missing?

3. China bailing its banks out would not qualify as a bail-out because all their banks are de facto part of the CPC's executive arm. They have much more power to enforce discipline and oversight than any stressed government, past or present.

Exactly why a differentiation between government debt and corporate debt, or between government debt and financial debt is disingenuous in China's case. Corporates and Financials are, for all practical purposes, branches of the government in China. Thus, to point out how low China's government debt is compared to the advanced economies is mendacious.

I don't doubt China's ability to reform. I question Xi's willingness and competence to do so. There is a difference between gradual reform and glacial reform, and it's turned into the latter under Xi, because he has drawn the wrong lessons from the collapse of the USSR. He has wasted the political capital that he built under the anti-corruption drive, using it to purge political rivals rather than push reform through the entrenched interest groups' resistance. In short, he has sacrificed the needs of China in order to strengthen the power of the CCP. He succeeded in that, and his control over the CCP is now stronger than ever. Now bureaucrats are too terrorized to take action, and the entrenched interests are busy consolidating the power of the SOEs. Per your metric above, how well has he dismantled the defenses of the entrenched interests? Here's what I see:

(Source: China’s state-owned zombie economy - FT.com )

Does that look like reform to you? Can you explain how the protection of these inefficient SOEs is good for China, or the Chinese people?

I project that your recipe is for a sudden transition into a weak-government with strong corporates, as was seen in 1990s Russia. This yielded many profitable opportunities for foreign oligarchs.

I have no desire to see China devolve into a kleptocratic oligarchy along the lines of Russia. On the contrary, I have been calling for reform for years to avoid precisely that fate. Russia became a kleptocracy because it delayed reforms until it was faced with a crisis, and then it had no choice. China still has a choice, but will it make it in time?

On a side note, what "foreign oligarchs" benefited from the shock therapy privatization of Russian SOEs? As far as I know, all of the Russian oligarchs are Russian.

 

[jhungary]

@jhungary @Shotgunner51

It took me a while to read through this thread, and it looks like @PARIKRAMA already addressed most of the issues. I just wanted to add a few minor details to help bridge the gap between what the two of you are arguing about.

1) NIIP is a sub-set of a nation's balance sheet, so to rely on NIIP as a proxy for fiscal health is a mistake (see Japan).

2) NIIP uses book value for several of its components, because market valuation isn't possible or practical. Especially in China's case, where it extends loans to unworthy borrowers overseas in order to advance its OBOR initiative, the value of those "assets" is likely overstated and should be written down. Most independent analysts already believe that China's NPL ratio is vastly understated for its domestic loans--why should it be different for its foreign loans? China has a poor track record with its overseas investments.

3) NIIP as a percent of GDP is declining, therefore becoming less relevant:

(Source: All about China’s public-to-private foreign asset swap | FT Alphaville )

4) China's central government debt is low.

5) China's total debt (household, corporate, financial, local government, central government) debt is very high, especially for an emerging market. We have all seen the McKinsey study:

Everyone is piling on debt:

But China is in a league of its own:

(Source: Debt and (not much) deleveraging | McKinsey & Company )

(Source: China’s Total Debt Load Equals 282% of GDP, Raising Economic Risks - Real Time Economics - WSJ )

China's debt is not only high, it is accelerating quite fast. Hence Moody's apprehension.

6) @PARIKRAMA @Spectre and @ito wisely raised the issue of contingent liabilities. What is considered corporate debt will eventually become government debt, due to the government's implicit guarantee of SOE debt. And we all know that many SOEs must either be directly bailed out, or indirectly bailed out by pressuring the banks to roll over their NPLs to these SOEs instead of writing them off and cutting off credit. And then we must discuss bailing out the banks (i.e. financial debt now becomes government debt). But that's a discussion that belongs in the over-arching theme of China's structural reform process.

Finally, I think the two of you (@jhungary @Shotgunner51 ) have gotten lost in the weeds on your argument, and lost perspective of the bigger picture, namely: is China financially stable? The answer is yes. Moody's is not downgrading China to non-investment grade status, and it's not even downgrading China's rating. It is putting China on a negative rating watch, identifying issues that China must address in order to prevent a downgrade.

Xi Jinping has unfortunately proven to be less competent than was originally hoped when it comes to restructuring China's economy, so it's possible he will continue to avoid the hard decisions that are necessary to get China back on a firm footing. You know, the reforms he already promised to do, but has been too afraid to actually carry out (financial liberalization, opening the capital account, floating the RMB, privatizing SOEs, etc.).

If China is lucky, Xi Jinping will return the power to manage to economy to his premier, Li Keqiang, who has a much better grasp of the situation than Xi. China can still turn the situation around and set itself up for another period of robust growth while it moves beyond the middle income trap.

If China is not lucky, we may begin to see a "going Japanese" process, with no hard landing, but rather a long period of stagnation as the financial system becomes beholden to zombie companies, while China's future, its SMEs, are starved of credit.

Unfortunately, Xi will be in power well into the 2020s, so unless he suddenly gets religion (and he's not--he's moving to further consolidate CCP control over the economy, in fact), it's more difficult to be optimistic about China's reform process until he's gone.

lol, actually, I never said China was not fiscally stable. I think I have mentioned multiple time that the article said that the reason why moody does not downgrade the rating is a sign that the situation is far from unstable, they can still finance a reform and restructuring if they want to. The outlook, on the other hand, is grim. Just then someone barge in and call for my ban for "Spreading false information" which basically the same thing you said.

However, ;like you said, I do not see a clear way China is paving a way to any actual reform even after 2 currency adjustment and being accepted into SDR.....

 

[TheTruth]

Regarding how well Xi is reforming, perhaps you can present a checklist of successes that he has achieved. I have clearly been misinformed, because all I can see is the failure of the much-touted Shanghai Pilot Free Trade Zone, failure to increase the "decisive role of market forces" on the economy (deregulation, privatizing SOEs, increasing credit to SMEs, floating RMB, relaxing capital controls, non-intervention in the stock market, etc.), opening up the economy to foreign investment, etc.

1. He downsized military entitlements that were being used to supplement PLA incomes
2. He is shutting down inefficient coal and steel overcapacity. Up to 6 million will be laid off in three years.
3. He is actually enforcing environmental laws that has put polluting and inefficient industries on the defensive
4. A lot of corrupt officials have been purged, many of whom held high positions in SOEs
5. He is even running a soft campaign against smoking, when the tobacco industry has long been seen as invulnerable
6. The financial sector has indeed been liberalized but it's a collection of dozens of minor changes; the PBOC's behavior has changed, financial oversight bodies have been given more power and streamlined, etc.
7. Internationalization of China's financial sector has been growing rapidly, though the base is indeed low.

Too many things have changed to count.

Exactly why a differentiation between government debt and corporate debt, or between government debt and financial debt is disingenuous in China's case. Corporates and Financials are, for all practical purposes, branches of the government in China. Thus, to point out how low China's government debt is compared to the advanced economies is mendacious.

There are two sides of issue. Yes, it is de facto government debt but that also means that the multi-trillions held by Chinese SOEs are de facto CPC assets. US and EU governments cannot use their big banks as an arm of fiscal policy, China can and has been doing so for decades.

He has wasted the political capital that he built under the anti-corruption drive, using it to purge political rivals rather than push reform through the entrenched interest groups' resistance. In short, he has sacrificed the needs of China in order to strengthen the power of the CCP.

This is largely unsubstantiated and speculative. Likewise putting all the SOEs together (telecoms, energy, steel, tobacco, so on and so forth) into a single graph does not make sense. A lot of SOEs are undergoing structural reform, for example steel-makers. Likewise easing down from boom years does not mean they're suddenly doing poorly.

On a side note, what "foreign oligarchs" benefited from the shock therapy privatization of Russian SOEs? As far as I know, all of the Russian oligarchs are Russian.

Their business partners.