The world’s second-largest economy is experiencing the consequences of a major housing crisis, significant blows to its labour markets, and strict enforcement of its zero-COVID policy
China’s debt levels are once again making headlines.
The Asian giants mounting debt levels, economic slowdown (an inability to jumpstart following the pandemic), and property crisis have raised concerns among ratings agencies leading to a downgrade in the country’s debt outlook.
Moody’s recently cut its outlook on China’s government debt to negative from stable. Historically, about one-third of issuers have been downgraded within 18 months of the assignment of a negative rating outlook.
China’s authorities likely need to provide more support for debt-laden local governments and state firms which pose “broad downside risks to China’s fiscal, economic and institutional strength,” Moody’s said. It also cited “increased risks related to structurally and persistently lower medium-term economic growth and the ongoing downsizing of the property sector.”
Responding to Moody’s statement, China’s Finance Ministry called the decision disappointing and stressed the economy would rebound. The authorities also said the property crisis and local government debt worries were controllable.
“Moody’s concerns about China’s economic growth prospects, fiscal sustainability and other aspects are unnecessary,” the ministry said.
For large corporates, these downgrades could mean higher borrowing costs, as the risk associated with investing in bonds and other debt increases. This could lead to a tightening of credit conditions, making it more difficult for companies to secure financing for their operations and growth initiatives.
CFOs will need to adapt to this new financial landscape.
This has been the first change by Moody’s to its China rating since downgrading it by one notch to A1 in 2017 when debt levels were rising.
While Moody’s affirmed the A1 rating on December 5, noting that the economy still had a high shock-absorption capacity, it has estimated China’s economic growth would slow to 4.0% in 2024 and 2025.
S&P Global has also chimed in noting its big concern was that “spillovers” from any worsening in the property crisis could push China’s gross domestic product growth “below 3%” next year.
Corporates will will need to reassess their financial strategies, focusing on maintaining liquidity and managing risk. This could involve diversifying funding sources, renegotiating terms with lenders, and implementing stricter cost control measures.
Moreover, CFOs will need to keep a close eye on the currency market. Recent reports indicate that China’s major state-owned banks have been seen swapping yuan for US dollars in the onshore swap market and selling those dollars in the spot market to support the yuan. This could lead to currency volatility, which CFOs will need to manage to protect their companies’ bottom lines.
In addition, CFOs will need to consider the potential impact of the debt situation on their companies’ credit ratings. A downgrade in the country’s sovereign credit rating could lead to a domino effect, resulting in downgrades for corporates as well. This could further increase borrowing costs and potentially limit access to capital markets.
1.Enhanced Risk Management: CFOs should prioritize comprehensive risk assessments, focusing on the impacts of China’s debt situation on their business operations. This involves a meticulous evaluation of investment vulnerabilities and supply chain dependencies on the Chinese market.
2. Strategic Diversification: Reducing reliance on China through diversification of investments and supply chains is a prudent step. Exploring alternative markets and sourcing strategies can mitigate potential disruptions stemming from the Chinese economy.
3. Robust Liquidity Strategies: Maintaining a solid liquidity position is imperative. This means keeping sufficient cash reserves and securing flexible credit facilities to ensure operational resilience amidst market volatility.
4. Astute Currency Management: With the yuan’s value potentially fluctuating, adept management of currency exposure is crucial. Utilizing financial derivatives like forwards and options can be effective in hedging against currency risks.
5. Regulatory Vigilance: Staying updated with China’s regulatory landscape is vital. CFOs must closely monitor policy changes related to finance and debt, ensuring compliance to maintain smooth operations.
6. Comprehensive Scenario Planning: Developing various financial and operational scenarios allows CFOs to be prepared for different outcomes of China’s debt issues. This includes having contingency plans for scenarios like market demand shifts or supply chain interruptions.
7. Clear Stakeholder Communication: Transparency with stakeholders regarding the company’s approach to managing risks associated with China’s debt is key. Effective communication helps manage expectations and maintain trust.
8. Leveraging Local Expertise: Forming alliances or seeking advice from experts familiar with the Chinese market can offer valuable insights and guidance.
9. Investment in Tech and Innovation: Investing in technology and innovation can drive efficiency and open new growth avenues, crucial in periods of economic uncertainty.
10. Dynamic Financial Reassessment: Continuously reassessing and adjusting financial strategies in response to evolving situations is essential. This includes re-evaluating investment plans and operational strategies in light of the latest economic developments in China.
Chinese authorities, in a notable fiscal manoeuvre, disclosed its intention in October to issue sovereign bonds valued at 1 trillion yuan (equivalent to $139.84 billion) by the close of this year. This strategic decision is aimed at revitalising economic momentum.
It accompanies an upward revision in the 2023 budget deficit target, now set at 3.8% of GDP, a rise from the initially planned 3%.
This move comes in the backdrop of China grappling with financial strains brought on by prolonged periods of excessive investment. Additionally, the declining revenue from land sales and the heightened expenses incurred in combating the COVID-19 pandemic have further strained the fiscal situation.
These factors have led rating agencies to express concerns over the potential risks associated with the significant debts borne by Chinese local governments.
The scale of local government debt in China has been a growing concern. In 2022, this debt escalated to 92 trillion yuan (about $12.6 trillion), representing 76% of China’s Gross Domestic Product (GDP), as reported by the International Monetary Fund (IMF). This marks a substantial increase from the 62.2% ratio observed in 2019.
Concurrently, there has been a noticeable surge in capital outflows from China. September saw a striking $75 billion leaving the country, marking the largest monthly outflow since 2016, as per the data provided by Goldman Sachs. This trend underscores the challenges facing China’s economy and highlights the significance of the government’s recent fiscal measures.
