China has been issued another yellow card.
In a report released last week, S&P Global Ratings warned that China is at risk of losing its “AA” status if it does not rein in its debt-fueled economic growth.
“Credit growth in China continues to outpace income growth, and much new lending appears to be financing public investment,” S&P analysts Kim Eng Tan and Xin Liu wrote. “Consequently, we see support for the Chinese sovereign ratings gradually diminishing.”
ANOTHER BLOW
Such a downgrade would be the latest blow to the world’s second-largest economy, whose outlook was slashed from stable to negative by the ratings agency in March.
At the time, S&P cited the country’s slower-than-expected economic rebalancing and the growing financial risks.
In the latest report, Tan and Liu found China’s “reliance on public investment to fuel economic growth to be unsustainable and a credit weakness” with little sign of the trend abating in the near future.
High volatility in the country’s stock markets and foreign exchange rates since last year, means that the Chinese government has kept the economy afloat by injecting borrowed money into public projects.
This in turn resulted in a yawning gap between public and private investment this year.
“Without this boost, it’s unlikely that the economy would have been able to keep growth at above 6.5 percent in the first half of 2016,” the analysts added.
While low and stable funding costs have kept the problem somewhat contained, the pace of credit expansion is increasingly tying the hands of Beijing’s policymakers, Kim and Xin said.
The rapidly growing debt pile lowers savings rates in a country that boasts an extraordinarily high tendency to hoard money.
When its aging population is taken into account, China’s debt-to-income ratio would rise even more rapidly, the analysts said.
This would further weaken the cushion provided by the large pool of domestic savings.
HURTING CONFIDENCE
“If China continues to rely on credit-driven investments as a key source of economic growth, confidence in Chinese growth prospects may diminish,” Tan and Liu said.
“This could trigger another surge in outflows of domestic savings that would increase the risk to interest rate stability,” they said.
To avoid a downgrade in its sovereign rating, the analysts suggested that China rein in credit creation in line with income growth in a swift manner.
“The longer the government takes to bring lending growth in line with income growth, the greater the pressure on the sovereign ratings,” they said.
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