By Nick Mann | 16 April 2013
Uncertainty over the finances of China’s local government has prompted Moody’s to change its outlook on the country’s Aa3 credit rating from ‘positive’ to ‘stable’.
In a statement issued this morning, the ratings agency said that China’s ‘robust’ economic growth and strong central government finances remained consistent with the rating, which sits three levels below the top triple-A rating.
China’s economy is expected to grow by between 7.5% and 8% of gross domestic product this year and next, while its budget deficits since 2008 have been 1%–2% of GDP and its debt burden is below 30% of GDP – and falling.
However, Moody’s noted that progress in reducing the risks associated with local government finance had been ‘less than anticipated’. In particular, the sector’s contingent liabilities – potential costs that could be incurred in a worst-case scenario – should be made more transparent.
China’s National Audit Office originally identified RMB10.7trillion (£1.13trn) in ‘local level’ liabilities at the end of 2010 – equivalent to 27% of China’s GDP at that point – with RMB6.7trn (£700bn) of this listed on local government budget balance sheets.
But Moody’s said that ‘uncertainty lingers over whether these figures represent the full extent of the contingent risks arising from local government financing vehicles’. Last week, China’s former finance minister Xiang Huaicheng was reported to have claimed local government debt was double that identified by the NAO report.
These costs could ‘encumber the central government's balance sheet and derail the transition to a more balanced and more moderately growing economy’, Moody’s explained.
‘Additionally, the increased dependence of local government budgets on land sales introduces a considerable degree of vulnerability to volatility in the property market, and hence the health of their finances, and the possibility of a need for greater central government support,’ it added.
Moody’s also raised concern over the ‘shadow’ banking system – lending by non-bank institutions that is beyond the scope of Chinese government policy instruments.
‘Macro-prudential regulations and the advancement of financial sector reform – such as interest rate liberalisation [and] the establishment of a transparent municipal bond market at the local government level – would help ensure that this shadow system does not destabilise the financial system in the future,’ it said.
China could face a downgrade if its economy slowed down by more than expected or if government finances deteriorated as a result of the risks they faced becoming reality, Moody’s said. A rise in social unrest which ‘distracts the authorities from the conduct of sound economic and financial policies’, could also put downward pressure on the rating, it added.
However, greater certainty and transparency that local government debt would not hinder the ‘very strong’ financial strength of central government could lead to a positive rating action, as could evidence that more moderate economic growth is sustainable in the long term.
