Moody’s Investors Service was something of a thorn in global policymakers’ sides in 2023. From Beijing to Washington, the ratings giant fired any number of shots across the bows of the biggest economies.
In mid-November, it lowered America’s credit outlook to “negative” from “stable”, pointing to political polarization in Congress as the US national debt topped US$34 trillion. Three weeks later, Moody’s cut its outlook for Chinese sovereign debt to “negative,” citing a slowing economy and a property sector crisis that Beijing has been slow to address.
Now, Moody’s is reminding Asia of the economic trauma 2024 may have in store as China’s slowdown imperils sovereign creditworthiness across the region.
Moody’s thinks the fallout from China’s property troubles on business and household confidence makes hopes for 5% economic growth in 2024 overly optimistic. It sees mainland gross domestic product (GDP) slowing to 4% this year and next.
For an economy at China’s level of development, such a downshift from the 6% growth averaged from 2014 to 2023 will set back living standards. And it will exacerbate the debt troubles Moody’s flagged last month, both among developers and local governments around the nation. It also may spark legitimacy problems for Xi Jinping’s Communist Party.
China’s slowdown “significantly influences” regional economic trajectories via supply chains, Moody’s says. “As these economies’ respective manufacturing bases are smaller in scale and less developed than China’s, the latter will remain at the center of many of the region’s supply chains and an important source of final demand in the near term.”
True, Moody’s argues that “against this backdrop, we expect companies to continue to diversify supply chains away from China to better manage risks around overarching geostrategic tensions, but also in response to longer-term structural trends.”
These “include population aging and policy risks in China – as illustrated in internet platforms and private education sector regulatory changes – as well as the rapid expansion of the middle class in India,” Moody’s says.
“The diversification trend,” Moody’s goes on, “has accelerated in recent years, boosting investment prospects in economies with large manufacturing bases and improving infrastructure such as India, Malaysia, Thailand and Vietnam.”
But such pivots take time to execute. Rerouting trade routes is complicated in the best of times and even more so in relatively tight global credit conditions.
In recent weeks, traders have dialed back expectations for US Federal Reserve interest rate cuts. The People’s Bank of China, meanwhile, has been far less generous about adding liquidity than most economists, analysts and investors expected.
In addition to the “lackluster situation in China,” says Moody’s analyst Christian De Guzman, tight credit conditions are an added headwind for the region.
“This,” De Guzman told CNBC, “is predicated on global liquidity conditions where we really don’t see the Fed easing until the middle of the year. And Asia-Pacific central banks – we don’t see much decoupling [from] global liquidity conditions there.”
It’s not just that China may be less of a global economic engine going forward. In 2023, Chinese imports contracted by 5.5% amid weak domestic demand. That means China’s 5.2% economic growth rate in 2023 didn’t generate much of a tailwind in Asia.
The bigger problem is how China’s financial risks may stress-test a region still dealing with the fallout from the Covid-19 era. In recent years, governments and companies borrowed aggressively to recover from the pandemic.
In its report, Moody’s warns that elevated global interest rates will worsen debt-servicing burdens. The upshot is that gaining access to international capital will become increasingly more difficult for lower-rated governments.
That will be a problem for China as much as anywhere, if not more. It’s sure to have a cooling effect on President Xi’s economy, notes Moody’s economist Harry Murphy Cruise.
“Real estate investment, dwelling prices and new dwelling sales are set to fall throughout 2024 before returning as a modest driver of growth in 2025,” he predicts.
Yet this could reflect wishful thinking if Xi’s team doesn’t act more forcefully this year to repair the property sector, including by creating a credible mechanism to get bad assets off balance sheets. A similar effort is needed to address the $9 trillion buildup of local government financing vehicle (LGFV) debt.
As these headwinds intensify, the Asia-Pacific region’s sovereign creditworthiness in general is deteriorating. These “tight international funding conditions will curb the region’s output,” Moody’s warns.
For its constellation of 25 sovereigns in the region, Moody’s sees GDP growth falling to an average 3.6% in 2024 from 4.2% last year. That, the rating agency’s analysts say, marks the “lowest rate of expansion in a non-pandemic year in at least two decades – reflecting a slowdown in China and broadly lackluster global economic conditions.”
Slower growth, Moody’s adds, will make it even harder for most governments to reduce Covid-era increases in public debt.
“Together with tight domestic labor markets, this will spur many APAC central banks to maintain tight monetary policy and mitigate currency depreciation risks,” Moody’s says. “International financing will remain difficult for lower-rated sovereigns, particularly frontier markets with large external payment needs.”
On Monday, China’s Premier Li Qiang called for more assertive steps to halt the plunge in mainland stocks, which are now at a five-year low. That’s easier said than done as global investors react to deepening deflationary pressures and a festering property crisis many economists compare to Japan’s banking debacle in the 1990s.
Even if the PBOC were to begin easing suddenly — something it’s avoided doing so far — the moves have already been priced in the market, says Eva Lee, head of Greater China equities at UBS Global Wealth Management. Only a much “punchier” monetary response might stabilize the situation, she adds.
Global “passive” funds are becoming far more assertive in hedging China risks. “Their recent selling did amplify the downside pressure,” says analyst Gilbert Wong at Morgan Stanley.
The reason is that “the Chinese government has not yet introduced effective measures to resolve the property turmoil and drive the economic recovery,” says strategist Ken Cheung at Mizuho Bank. This, he adds, has overseas investors continuing to “reduce their risk exposure” amid “bearish expectations” for China’s outlook.
Here, expectations versus reality are becoming a problem for investor sentiment. Generally, Premier Li has “doused” hopes for further support measures, notes Brian Martin, an analyst at ANZ Research.
As Li “trumpeted the nations’ ability to hit its 5% growth target without flooding the economy with massive stimulus,” investors were left fearing Beijing had lost the plot, he said.
Surely, Xi’s inner circle may have valid reasons to be confident about China’s 2024. It’s entirely possible that the economic dashboard Xi’s men are viewing suggests aggregate demand will bounce back sooner than most investors believe.
At the same time, Xi’s party is loath to squander progress made in financial system deleveraging. Beijing’s determination not to reward bad behavior and poor lending decisions is to be applauded. Still, if China’s trajectory is less dire than markets think, Xi’s team is doing a poor job spreading the news.
Even taking a glass-half-full approach to China’s 2023 performance requires an asterisk. “While the economy did beat the official target, it could have scored a higher grade through a more forceful response to the property meltdown and greater commitment to the private sector,” says Tianchen Xu, a senior economist at the Economist Intelligence Unit.
Downward pressure on the yuan also suggests the economy is less vibrant than Beijing’s spin would have investors believe. On Monday, Reuters reported that major state-owned banks are propping up the exchange rate. The rationale, Reuters notes, is to disincentivize traders from shorting China’s currency.
A deeper drop in the yuan might also add to default risks among distressed property developers and intensify selling of China’s A shares. So far this year, overseas funds have dumped upwards of $1.6 billion worth of Chinese equities.
“The PBOC has stepped up its efforts to restrain dollar-yuan through the daily fix lately, and this is keeping a lid on” the exchange rate “at the 7.20 level,” says Alvin Tan, head of Asia FX strategy at RBC Capital Markets. “But I think it should give way to the upside soon.”
In recent days, Tan notes, the PBOC and Beijing’s foreign exchange regulator stepped up to “strengthen market expectation guidance and take actions to correct pro-cyclical and one-way market behaviors when necessary.”
Julian Evans-Pritchard, head of China economics at Capital Economics, says the PBOC’s decision Monday to hold benchmark lending rates steady proves that policymakers “appear to harbor lingering concerns” about the yuan.
“A cut at this stage could trigger additional depreciation pressure, something the PBOC wants to avoid,” Evans-Pritchard says. “Therefore, it may stick to quantitative easing tools for now,” including supplementary lending efforts.
This, too, is part of Xi’s desire not to derail success in building trust in the yuan. A stable exchange rate remains key to making China Asia’s top financial power. As such, Xi appears to care more about a strong currency than rising stocks.
There are also geopolitical threats to consider as US voters choose a new president in November. As US President Joe Biden looks to outflank Republicans loyal to Donald Trump by being tough on China, new sanctions could emerge.
Tensions in the Red Sea and Russia intensifying its Ukraine war could boost energy prices and thus inflationary pressures in the year ahead.
All this puts sovereign ratings across Asia in harm’s way. A bigger trade war is a particular wildcard. As Washington and Beijing face off in the year ahead and related risks become “more prominent,” Moody’s warns, Asian governments will find it increasingly difficult to maintain financial balance.
Moody’s adds that “competition between China and the US is resulting in regionalization of trade and shifts in economic and financial influence” in the longer run. In the shorter run, though, such disruption is another reason for investors to worry about threats to sovereign ratings in 2024.
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