China’s Rising Debt Spurs Moody’s to Lower Credit Outlook

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

Moody’s expressed concern at the potential cost to the national government of bailing out debt-burdened regional and local governments and state-owned businesses. Moody’s, which previously viewed China’s finances as stable, warned that the country’s economy is settling into slower growth while its enormous property sector has begun to shrink.

China’s Ministry of Finance immediately pushed back, saying that the Chinese economy is resilient and that local government budgets could withstand their loss of revenue from the country’s real estate downturn.

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

The lowering of the credit outlook nonetheless marks an important milestone for China’s economy.

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

Today China faces increasingly serious budget constraints, triggered mainly by a steep slide in the real estate sector. The construction of apartments, factories, office towers and other projects has been the country’s largest industry, accounting for 25 percent of economic output. Apartments are also the main investment for most households, 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 for the last 15 years. The money the local governments pulled in from lenders has generated high economic growth, but many of them are now in serious trouble.

For China, the change in the credit outlook will have little direct effect on its finances. Unlike many countries, China relies very little on overseas borrowing. 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 had emphasized China’s economic leadership during the global financial crisis in 2008 and 2009, when the American housing market suffered a sharp correction. Now China faces a similar and possibly larger housing downturn. Dozens of large real estate developers are insolvent and unable to finish hundreds of thousands of apartments for which they had already accepted large deposits.

Developers have left behind hundreds of billions of dollars in overdue bills to small businesses and other contractors, triggering a cascade of payment troubles. With the exception of a few state-owned businesses, developers have mostly stopped buying land for future housing construction.

Land sales had been the main source of revenue for local governments. Many of them now face a crisis as their revenue from these sales has plummeted. In its statement on Tuesday, Moody’s said that the national government will likely have to help these governments cope.

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

“The outlook change 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 said.

China’s Ministry of Finance rejected Moody’s arguments. It said that while local government revenues from land sales had fallen, the same governments are also spending less to compensate residents whose homes are bulldozed to make way for new buildings. The ministry also asserted that China’s economy still has considerable momentum.

China is not alone in being on the receiving end of Moody’s concerns. The agency lowered its credit outlook for the United States to negative last month while reaffirming the country’s top level AAA rating.

Overall debt is now higher in China, relative to the size of its economy, than in 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 less concern than Moody’s about China’s economy. Several hours before the Moody’s announcement on Tuesday, S&P said that it believed China could avoid replicating Japan’s “lost decade” of weak economic activity following its housing slump in the early 1990s.

Fitch Ratings told Bloomberg television earlier this year that it might reconsider China’s sovereign bond credit score, but recently affirmed that rating with a stable outlook.

The Chinese economy has endured a bumpy emergence this year from nearly three years of stringent “zero Covid” measures, including many of the world’s longest and strictest municipal lockdowns.

The economy grew at an annual pace of 5.3 percent from July through September. A debt-fueled surge in investments by manufacturers and fairly robust spending at restaurants and hotels offset a fall in apartment construction.

Data for October and November has been mixed. Investment remains 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 but also among adults. This has emptied many restaurants and other service-sector venues.

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

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