In another blow to the Chinese economy, ratings agency Moody’s said on Tuesday it had issued a negative outlook on the Chinese government’s financial health.
Moody’s expressed concern about the potential costs to the national government of rescuing debt-burdened regional and local governments and state-owned companies. Moody’s, which previously viewed China’s finances as stable, warned that the country’s economy is growing more slowly while its huge real estate sector begins to shrink.
China’s Finance Ministry quickly pushed back, saying the Chinese economy was resilient and that local government budgets could absorb the loss of revenue due to the country’s real estate decline.
At the same time, Moody’s confirmed the Chinese government’s overall creditworthiness of A1. A negative outlook on a credit rating does not necessarily lead to a downgrade soon, but serves as a warning that the existing rating may not be sustainable.
Still, the reduction in the credit outlook represents an important milestone for China’s economy.
Until recently, China had seemingly unlimited resources to spend on the world’s largest high-speed rail network, a massive military buildup, subsidies to manufacturers and major construction projects abroad.
Today, China faces increasingly severe budget constraints, driven primarily by a steep decline in the real estate sector. The construction of apartments, factories, office towers and other projects is the country’s largest industry, accounting for 25 percent of economic output. Housing is also the primary investment for most households, accounting for three-fifths or more of their savings.
While Chinese government borrowing has been limited, local and regional governments and state-owned enterprises have borrowed heavily over the past 15 years. The money that local governments have taken from lenders has led to high economic growth, but many of them are now in serious trouble.
For China, the change in credit outlook will have little direct impact on its finances. In contrast to many other countries, China is hardly dependent on loans abroad. The national government sells bonds primarily to the country’s state-owned banks. The country’s regional and local governments and state-owned companies also sell them bonds.
Beijing had emphasized China’s economic leadership during the global financial crisis in 2008 and 2009, when the American real estate market suffered a sharp correction. Now China is facing a similar and potentially larger real estate downturn. Dozens of major real estate developers are insolvent, unable to complete hundreds of thousands of apartments for which they had already accepted large deposits.
Developers have left hundreds of billions of dollars in past-due bills to small businesses and other contractors, triggering a cascade of defaults. With the exception of a few state-owned companies, developers have largely refrained from purchasing land for future housing construction.
Land sales were the main source of revenue for local governments. Many of them are now in crisis as their income from these sales has plummeted. In its statement on Tuesday, Moody’s said the national government will likely need to help these governments cope.
Difficulties in the real estate sector have slowed economic growth, contributed to high youth unemployment and made many families reluctant to spend money.
“The change in outlook also reflects the increased risks associated with structurally and persistently lower medium-term economic growth and the continued downsizing of the real estate sector,” Moody’s said.
The Chinese Ministry of Finance rejected Moody’s arguments. It says that while local governments’ revenue from land sales has fallen, those same governments are also spending less to compensate residents whose homes are bulldozed to make way for new buildings. The ministry also stressed that China’s economy still has considerable momentum.
China is not the only one affected by Moody’s concerns. The agency last month cut its credit outlook for the United States to negative while affirming the country’s top AAA credit rating.
China’s total debt, relative to the size of the economy, is now higher than that of the United States.
China’s credit rating was last downgraded in 2017 by both Moody’s and S&P Global Ratings. More recently, S&P has expressed fewer concerns about the Chinese economy than Moody’s. A few hours before Moody’s announcement on Tuesday, S&P said it believed China could avoid a repeat of the “lost decade” of weak economic activity in Japan following the real estate collapse of the early 1990s.
Fitch Ratings told Bloomberg television earlier this year that it may reconsider the creditworthiness of Chinese government bonds, but recently reiterated that rating with a stable outlook.