Moody’s downgrades China

Moody’s downgraded China’s sovereign credit rating from Aa3 to A1 and upgraded its outlook for the rating to ‘stable’ from ‘negative’. That is, it does not expect to downgrade China again anytime soon.

As soon as it happened, many dismissed it. China government does not borrow in foreign currency and hence, a credit rating action by an international agency does not really matter. Well, not so fast. Even Indian sovereign does not borrow in foreign currency. Yet, its credit rating is just above junk bond rating and is often cited in many commentaries on India’s fiscal health. So, let us not be too nonchalant about it, on behalf of China. Certainly, the Chinese government won’t be.

The fact is that this is the first China rating change by Moody’s in nearly thirty years. It does make people sit up and take notice. Second, China has just come off the OBOR conference where it assembled many foreign leaders. It was almost an emperor’s durbar with the little chieftains in attendance. Hence, to have this happen within a week of that jamboree is a bit of an embarrassment that China could have done without.

For China, ‘face’ matters a lot and hence, a foreign credit rating agency from a country that is, in its view, fast losing its pre-eminence is a reminder to China that the world order had not changed yet. That would be quite annoying.

For India, it would be a bit of a Schadenfreude because India had raised questions about the debt burden it would create for the countries involved. Moody’s downgrade vindicates India in a way.

Second, Arvind Subramanian, the Chief Economic Advisor to the Government of India had been fiercely critical of the credit rating agencies for their lopsided credit rating of India and, say, China. He called the chasm between the sovereign credit ratings of both countries indefensible. India was just above junk bond rating and China’s credit rating was Aa3. He might be somewhat mollified or feeling vindicated although he was batting for an upgrade for India and not so much a downgrade for China.

As for China’s economic fundamentals, they had justified more than a one-notch downgrade long time ago. In its Article IV report last year, the International Monetary Fund had pointed out that China’s ‘augmented fiscal deficit’ was slightly above 10% of GDP in 2016 (p.43). Its public debt ratio too is correspondingly much larger and rising. Even then, no one has the faintest idea of how much debt China’s local governments have taken on and how much of it would devolve on Beijing.

Further, China’s banks are swimming in a sea of bad debts to local government funding vehicles, to State-owned enterprises and, further, on their part, have sold these debts as Wealth Management Products to their private clients, looking for a higher yield with no risk. Their official non-performing asset ratio is less than 2%. But, private estimates range from 5% to 25%. Fitchratings, another credit rating agency, puts it at 15%. Therefore, objective fundamentals warranted a lower credit rating for China.

A colleague had a legitimate question as to why this downgrade did not come earlier, when China’s fundamentals were dodgy as in, say, at the beginning of 2016 or in August last year, etc. The answer is simple. It is that the credit rating agencies did not want to pour oil into the fire and turn China’s turbulence into a self-fulfilling rout. It is better to do it when times are quieter.

Second, the scale of the estimates being touted for the ‘One Belt One Road’ initiative might have influenced Moody’s. It is our guess. The number is variously estimated at USD900bn to USD1.0trn. Hence, this downgrade could be a pre-emptive warning.

The downgrade, while being meaningfully negative for those borrowers that rely on the sovereign rating to price their own debt, may also make the Chinese government think a bit harder about the next round of debt-funded reflation once it gets bored or frightened of the current round of de-leveraging that it is supposedly pursuing.

In all, Moody’s downgrade of China’s sovereign debt might not be a surprise but its timing was unexpected, surely. If anything, the surprise is that it took so long for them to act and the question is why only one notch down.

This article in the Wall Street Journal comparing China and Japan is a good read. Moody’s rates both countries alike now.

On rupee strength

Let me state at the outset that I am all for a strong currency PROVIDED economic fundamentals back it up. Strong capital inflows do not constitute ‘sound economic fundamentals’. They are hardly mirrors to fundamentals but of perceptions and that too of the relative variety. So too is the exchange rate. India’s economic growth is middling. It is unbalanced. Private capital formation is still missing. Savings rates have not risen.

So, the currency strength seems to be driven more by perception of India’s strength especially in comparison to other emerging economies, including China, rather than due to intrinsic strengths. That is why, perhaps, RBI has been intervening and that India’s foreign exchange reserves are rising.

This comment is not to take exception to Mr. Ninan’s Op.-Ed today in Business Standard. But, to raise one minor quibble. He had written:

The solution, suggested in this column seven months ago, is to focus on the source of the dollar surpluses: capital inflows, and debt inflows in particular.

Data do not support him – except for the last few months – that India’s dollar debt and equity flows had gone up. If anything, up to December 2016, India’s external debt and Net International Investment Position (IIP) positions have only improved. More repayments (outflows) than borrowings (inflows). Since February this year, India has witnessed strong Foreign Portfolio Investment (FPI) – both debt and equity.

Therefore, the point remains and he is right that India has not earned the right to have a strong currency. Most important of all fundamentals for a strong currency is productivity. India does not have the data because the bulk of the employment in the country is informal. Whether it is 75% or 92%, it does not matter. It is too high.

India is currently not facing headwinds or competitive disadvantage in a big way because other countries, including China, are not actively seeking to depreciate their currencies. That is something to keep in mind and watch out for. Chief Economic Advisor has indeed produced a chart of rising Indian rupee versus the Chinese yuan in his recent VKRV Rao Memorial Lecture. India does have a big bilateral trade deficit with China.

A friend helpfully points out that the focus on the INR/CNY bilateral exchange rate might be a road or bridge to nowhere. He said,

Between 2005 and 2015 the INR depreciated almost 90% against the CNY on nominal basis and about 60% on real effective basis while the bilateral trade deficit went up 24 times from around USD2bn to USD48bn. Not saying currency does not matter but in such cases global supply chains and productivity differentials seem to matter much more than currency divergence.

It is an excellent point. He is very right. I am reminded of what BIS wrote in its 2016 Annual Report on the declining usefulness of exchange rate depreciation for export growth:

Recent studies generally suggest that trade exchange rate elasticities have
declined in response to changes in trade structures, including currency denomination, hedging and the increasing importance of global value chains. For instance, a World Bank study finds that manufacturing export exchange rate elasticities almost halved between 1996 and 2012, with almost half of this decrease due to the spreading of global supply chains. [page 53 – Link]

Second, India’s overall REER has appreciated by about 7% to 9% in the last one year, depending on the metric that one chooses, from among the several that RBI publishes on a monthly basis.

We must remember that REER adjusts for inflation in India relative to that of other countries (trading partners). Inflation is an indirect measure of productivity. Therefore, REER is productivity adjusted in that sense. Even so, the rupee has appreciated in the last one-year or so. That could be a concern for whom export quality or excellence is not a core strength.

But, it has not hurt India much because crude oil has not sustained its price recovery of last year into 2017. This might persist for quite some time. If anything, the risk of further downside for crude oil price is higher than upside for crude oil. That is a good news for India. That is one reason India’s current account is not showing any strain from the rupee strength. Of course, the strength has been somewhat recent only.

It might be then that the Indian interest rates are still too high, relative to that of other countries. Perhaps, RBI is too tight. But, then who knows if India’s inflation has become sustainably low? RBI has not lowered rates because liquidity is otherwise ample, both in domestic financial institutions and from overseas. Their monetary policy might be tight, temporarily, but it has to be shown over time that it has become unsustainably too tight for too long, before the blame can be fully laid at its doors for the strength of the currency.

In sum, the situation calls for observation. The traffic light is amber. It is not red, signalling danger. Those were the days when Germany and Japan could become export powerhouses despite currency strength. It is true that no country depreciates its way to economic prosperity.

In the days of financial globalisation, it is unfortunately and equally true that no country can appreciate its way to external sustainability.

Tett, Trump and Comey

A disappointing piece by Ms. Tett.  As Senator Susan Collins said – and she is no admirer of President Trump – to put it mildly – the FBI Chief deserved to go. Further, she noted that Trump was not shutting down FBI. There are enough dirt diggers on Trump. One may not like him; one may even detest him for his values, for his policies and for his personality but President Trump is not a fool to walk into a suicidal trap. He would have known that he is handing a big stick for his detractors to beat him with.

Remember, he outsmarted the chattering classes to become the President. They guessed wrong and now all of them are trying to prove themselves right, by finding a reason to get rid of him.  To do so, they are perhaps barking up the wrong tree. The hyperventilation over Russia is a case of self-perpetuating logic.

Whether or not there was collusion with Russia that helped him win the Presidency – a very remote possibility –  there are serious conflicts of interest that are arising with China.

Kushner has almost single-handedly derailed the Trump agenda over China. From the aborted attempt on the part of Anbang insurance to bail out his failed real estate deals, to his children singing Mandarin songs for the visiting Chinese President and his wife to his family members selling U.S. Permanent Residency for real estate transactions claiming proximity with the highest office of the land, etc., there is plenty to worry about there.

China – with its unstable economy and its empire building – is a bigger threat to the global order than Russia. China ought to be a bigger worry for those who worry about the stability of markets.

Is it a sign of foolishly misplaced priorities that there is hyperventilation about Russia while China gets away with far less scrutiny or is it something more sinister?

In 2001, on the request of the Head of Citigroup Investment Banking Head, Robert Rubin, former U.S. Treasury Secretary telephoned a Treasury undersecretary in the new Republican Administration to ensure that Enron Debt was not downgraded. Citi was having a big exposure to Enron.

He could do so because Bill Clinton had rescinded a rule that barred Cabinet members from interceding with the Department that they had worked for.

Luigi Zingales, Professor at the University of Chicago, had recalled the incident in his book, ‘A Capitalism for the people’. That is the kind of ‘bipartisanship’ that America had witnessed in the last two or three decades in sinking the pillars of probity in governance.

Good journalists must know the issues that they ought to focus on.

Everything is under control – China linkfest

(Some links could be behind paywalls. Apologies)

China’s history problem: how it’s censoring the past and denying academics access to archives [Link]

Xi Jinping’s political theory system is complete now

China bans religious names for Muslim babies in Xinjiang

Why is this Xinhua edit invoking 1997 and 2008 crises? What is cooking?

China wants independent think-tanks to toe the party line

FT: The decision by Caixin — whose chief editor, Hu Shuli, also has strong relationships with Communist party officials — to publish its exposé suggests that the political winds are shifting against Anbang.

Yes, we should not forget that the media alone could make independent decisions when other elements of the society are not allowed.

WSJ: Screws tighten on risky Chinese insurance

WSJ: “China’s War on Debt Causes Stocks to Drop, Bond Yields to Shoot Up and Defaults to Rise.” I doubt if it is anything more than one of those ‘on-again, off-again’ thing or political hunting season.

Bloomberg: “The system-wide contraction is a result of a flurry of government measures over the past month that included ordering banks to bolster risk controls, stepping up scrutiny of shadow financing and cracking down on malfeasance among senior bureaucrats.”

A very good commentary on many things – on the world of ‘liberal’ media and on China – in one tweet.

Prof. Carl Minzner, Fordham School of Law, has given a speech at the India-China Institute in the New School on May 1 on China after the Reform Era. I requested him for a copy of the speech. He sent me this paper.

The implications of this Bloomberg story are many. Europe has no choice but to swallow a lot of things, if the biggest owner of its ‘Too big to fail’ bank is a Chinese group whose ultimate owner is…

Shandong province’ Zouping County’s Qixing Group is too big to fail for China and China is too big to fail for the world.

China’s credit excess is unlike anything the world has ever seen but, everything is under control

China’s Trump Card

I had written about how China appears to be getting tough on North Korea. At least, John Pomfret thought so and I had cited him in my MINT column on Tuesday. At the same time, I had considered the possibility that China could be ‘compliantly non-compliant’.

James Kynge has a superb piece (apologies if it is behind a paywall) on why China would not give up its ‘asset’ that North Korea is. I suppose it applies to Pakistan. All the more so, in the light of recent developments versus India. One has to doff one’s hat at them for the creative ways in which they practice statecraft.

In the meantime, India is signalling to the United States that it would take no prisoners on the H1B visa and other trade matters. It is a topsy-turvy world where everyone is unable to or is unwilling to see and assess the overall picture and come up with an overall balance sheet of relationships. It is no criticism. It has become almost impossible.

As I wrote in the previous post, moral outrage and ‘clarity’ are possible only if one practised selectivity with respect to issues. Repeat, this is now practised by all stakeholders. This is not a remark directed at India alone, here.

China March Trade Report

Chris Balding’s tweets – a compilation (April 12, 2017)

Small storm on Chinese trade data: it is very difficult to reconcile Chinese trade data with reality on two fronts. Not saying false just really straining credibility. Two examples: Exports to Latin America were up 16.4% in January and 6.3% through February. March likely show more big numbers.

Question: where is growth strong enough to drive USD exports that will likely by 10%+ in Q1?

Brazil had nominal USD GDP growth of 2.5% Feb 16->Feb 17. Even on the low side that puts GDP to trade ratio at more than 2. After March, likely well above 3 or even 4. Export growth rates being claimed seem extraordinarily large for growth we see elsewhere. One other problem the difference between the USD and RMB trade growth rates is nearly exactly the change the drop in the RMB. Sounds logical but it isn’t.

When a currency drops, importers know that the local currency price has dropped and negotiate new prices with the exporter. Example US Acme imports from Chinese Acme widget at $100 implied conversion of 600 RMB. When RMB drops, US Acme renegotiates new price rather US Acme imports from Chinese Acme widget at $100 implied conversion of 600 RMB. When RMB drops, US Acme renegotiates new price rather split the currency difference so importer does not enjoy 100% of currency drop. However, Chinese data implies this is happening.

Volumes of product out of China remain decidedly soft. Not sure yet exactly what is happening but there is more here than meets the eye. Through January/February 2017, 70% of major export categories experienced declines in the volume of exports compared to 2016.

Rebalancing the colour of the sky – China links

The 16 percent decline in hot-rolled coil prices over the past month, compared with a 7 percent decline in rebar, suggests that a reversal of that value proposition is underway. Instead of a robust private sector outspending the state, it looks like government cash is protecting the steel industry from a brutal slowdown in demand.

The stimulus from Beijing, however, is evidence that the country’s almost-forgotten ambition to rebalance away from investment and toward consumption is still a pipe dream. [Link]

Caixin notes that there were fewer days of blue skies in Beijing in the first quarter. that fits in with the story above and the story below. That means that smokestacks China is doing well and that rebalancing away from rebalancing.

FT reports:

Water-guzzling coal-conversion projects are springing to life in arid western China, setting the stage for the large-scale deployment of what was previously a niche industry. A three-year downturn in coal prices has revived projects that convert coal to motor fuel, petrochemical feedstock or gas, after many were shelved in 2008 because of concerns about water supply and pollution.

Projects that work in China’s state-dominated economy may not be practical elsewhere. Coal conversion has become profitable in China because of an unusual combination of low coal prices relative to state-set gas or petrol prices. Coal-to-liquids projects normally make economic sense only when oil prices are high or supply is limited. The technology was first developed in Nazi Germany, and commercialised in apartheid-era South Africa. [Link]

Natixis report on China’s first quarter trade data and GDP growth forecast for the first quarter also confirms that ‘old industries’ did well in the first quarter. No wonder, Beijing had few ‘blue sky’ days. That is a good barometer of China rebalancing or its absence.

I may have blogged on this earlier. But, it is worth repeating. The article ‘Alienation 101’ is about the life of Chinese students in the University of Iowa. American Universities, in search of incomes, had aggressively wooed overseas students, particularly Chinese. It has not gone down well. Indeed, try searching with the key words, ‘Iowa, China Students’ and you get some very interesting stories. This long article in the 1843 magazine of The Economist has a fascinating and yet chilling account of how China controls its students coming to study in the Universities in America and how it prepares to be the extended propaganda arms of the Communist Party and the Chinese government:

The Chinese students aren’t really disengaged, however. They are just immersed in a world that is largely invisible to the rest of the university. At its centre is the Chinese Students and Scholars Association (CSSA), funded and monitored by the consulate in Chicago. Its structure even mimics the Communist hierarchy, with a “propaganda department” and a tight circle of leaders tacitly approved by the consulate. It puts on four big events each year aimed almost exclusively at Chinese students, including a Lunar New Year gala marking the biggest holiday in China. Last November, Mingjian attended a CSSA “speed dating” show in which male students in tuxes declared their love for female students in flouncy dresses, with nearly 300 students egging them on. It was conducted entirely in Mandarin.

One of CSSA’s main purposes is to make students aware that Beijing is watching over them. A Communist Party directive last year exhorted members to “assemble the broad numbers of students abroad as a positive patriotic energy”. At Iowa, the effort starts even before the students leave China: at the university’s pre-orientation session in Shanghai last summer, student-information packets included a dvd produced by the Chinese consulate in Chicago called “Rules for Studying Abroad”. And in January, the CSSA posted on social media a Lunar New Year’s greeting from the Chinese students’ official minder, Chicago consul-general Hong Lei. “He is the idol of students in the United States!” the message went. “He is the pride of the Chinese people!”

The CSSA also stands ready to protest against any campus speaker deemed harmful to China’s interests. In February, the CSSA at the University of California, San Diego, blasted the university’s choice of commencement speaker, the Dalai Lama, whom Beijing considers a traitorous monk, saying in a letter that it was “awaiting the advice of the Consulate General.” Over the past few years, the Chinese government’s direct involvement in CSSAs has prompted two other universities, Columbia and Cambridge, to ban them temporarily.

While helping newcomers in from the airport, CSSA representatives welcome them with advice about settling in – and a reminder that their behaviour reflects on the entire Chinese nation. The students do not really need reminding, for their education at home has inculcated in them the virtues of, and importance of loyalty to, the Communist Party. Their own encounters with American students – whose views on China can be condescending, even hostile – tend to intensify their reflexive patriotism, even if, like Sophie, they choose to keep their opinions to themselves.

Outspoken patriotic fury tends to be reserved for fellow Chinese. Last October, after Professor Tang gave a talk about Beijing’s sensitivity to public opinion, he received an angry email from a Chinese student: “I’m so ashamed of you. You just bought into American propaganda against China. Where is your moral limit as a Chinese citizen?” Tang, who is now an American citizen, shakes his head. “This generation has been indoctrinated since day one.” [Link]

While I was searching for the above article, I ran into a five-part Reuters story on the tactics and methods that foreign students, particularly Chinese, employ to gain admission into American Universities. I just saw and read the third part. Links to other parts are available in the article. The ‘competition’ that hard working and sincere students are up against is frightening. The obsession to succeed at all costs and against all norms is not normal. It is a pathological obsession – a mental condition.

Benn Steil has some good charts on the Renminbi strength or the lack thereof. He says that RMB internationalisation has stopped. He is right. Chris Balding thinks that the analysis is flawed. I am not sure. Renminbi has stopped internationalising because the Chinese government is simultaneously exerting controls on exchange rate outflows and has also placed restrictions on foreigners’ repatriation! Benn Steil acknowledges that.

Brad Setser’s ‘Follow the Money’ blog is worth following. He is tracking China macro data and external data with clinical efficiency as he used to do before. He is a great resource. He has shown why it might be difficult to label China a currency manipulator now. He shows the periods in which it would have been appropriate to do so. That was mostly between 2005 and 2012. Both Bush and Obama were asleep at the wheel, then.

This sarcasm of his in the end, is well deserved (by China). Well, they had earned it!:

I also have great confidence in the ability of China’s authorities to engineer official outflows that would substitute (he means, ‘compensate’) for reserve growth should China start buying foreign exchange in the market. I consequently doubt that China will ever trigger the 2% of GDP in reserve growth threshold. But that is a topic for another time.

In another post, he has expressed scepticism on China’s current account balance having come down drastically in the last one year. Interestingly, current account balance is one of the parameters tracked under the IMF Exchange Rate surveillance and US Treasury’s Enhanced Enforcement Monitoring.

Lingling Wei’s long-form article in the Wall Street Journal is an important read. It shows the impossible set of foreign exchange goals that China is pursuing. Some predict – as I think – that China would let go off exchange rate stability in return for financial stability. We do not know when the tipping point arrives. China has been skilfully plugging the leaks in the dyke with band-aids, for several years now. It will be silly to venture and put a timeline on it.

China is tightening interest rates because the Federal Reserve is doing it. But, President Trump may have just gotten them out of jail on that one. See my MINT column on Tuesday (18.4) on that one.

Barrick Gold, the world’s largest producer of the precious metal, has agreed to sell a 50 per cent stake in one of its biggest mines to a state-backed Chinese company. [Link].

China tightens grip on football in Italy. A Chinese consortium has bought Berlusconi controlled football club AC Milan. Chris Balding calls it the purchase of a ‘money losing asset’ and that China is taking its economic model global!

Finally, two Martin Wolf pieces on China. One is about the impossibility of China escaping the debt trap and the second is about Chinese financial system storing up trouble for the rest of the world. Both are not new and nothing much that is not known has been said in these articles. China is ‘too big to fail’ in the eyes of the United States. North Korea is a physical security threat and China is a economic security threat.

The U.S. has no clear way – not that many have better answers – of handling both. It is buying time and appeasing and threatening alternately. The United States too has lost its ability to take them on and face the consequences. Its economy too is too weak and indebted. I guess this implosion or combined mutual assured destruction of China and American economies will happen when we least expect it to.