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.

Japan stagnation no more

The Cabinet Office has just revised the official GDP data in December to adopt the latest
System of National Accounts 2008 (SNA2008) international standards. The most significant change under the new methodology is that research and development costs are now recognised as capital expenditure. This revision has had the practical consequence of increasing Japan’s aggregate nominal GDP by over Y30tn. Thus, the 3Q16 nominal GDP figure has been revised up by 6% from an annualised Y506tn previously reported in November to Y538tn (see Figure 15). The Cabinet Office has, as a result of this revision, increased its official estimate of Japan’s potential growth rate from 0.4% to 0.8%.

The above revisions to the official GDP data also follow an extended discussion prompted by the publication of a BoJ research study last year, which employed a different methodology for calculating GDP than that traditionally used by the Cabinet Office (see BoJ working paper: Estimating Japan’s Gross Domestic Income Based on Taxation Data, December 2016. Japanese version was published earlier in July 2016). The BoJ study relied on data from the tax office while the Cabinet Office has traditionally estimated GDP by calculating aggregate supply and demand using a variety of statistical surveys. As discussed here last September (GREED & fear – Kuroda fading, 15 September 2016), based on the BoJ methodology Japan experienced a significantly higher growth rate over the past ten years than that recorded in the official data, most particular in fiscal 2014. Thus, under the BoJ methodology the economy expanded by 2.4% in real terms in FY14 compared with a 0.4% contraction based on the latest official data (revised up from a 0.9% contraction reported in mid-2016). Over a longer time frame the Japanese economy would have achieved average real GDP growth of 1.2% between 2004 and 2014 based on the BoJ methodology, not the 0.7% reported by the Cabinet Office (see Figure 16).

The above findings were embarrassing to the statisticians in the Cabinet Office, most
particularly as the weak data in 2014 provided the rational for Abe to delay a scheduled sales tax increase for the second time in October 2015. The sales tax is now due to be increased in October 2019. Meanwhile ongoing discussions between the Cabinet Office and the BoJ as regards the GDP data, discussions apparently requested by Abe, appear to be at least one reason motivating the latest revisions to the official GDP data. The result is that aggregate nominal GDP has now exceeded the previous high reached in 1997 (see Figure 15). This is another sign of easing deflationary pressures.

As also previously discussed here, yet another signal that life in Japan is not as grim as was the case ten and more years ago is the remarkable collapse in the suicide rate. Thus, the number of suicides in Japan peaked at 34,427 in 2003 and has since declined to 21,898 in 2016, the lowest level since 1994 (see Figure 17). It is not a coincidence that this data series peaked out in 2003 and has now returned to the levels prevailing in the early 1990s. It is even the case that the fertility rate has picked up in recent years, bottoming out at 1.26 in 2005 and since recovering to 1.45 in 2015 (see Figure 18). Indeed the Japanese fertility rate is now running above levels prevailing in Hong Kong (1.20), Singapore (1.20) and Korea (1.17). Meanwhile the Abe government’s target is to boost this to 1.8 in the medium term.

Source: ‘Riding the Donald’, ‘Greed & Fear’ Weekly by Christopher Wood, CLSA (February 23, 2017, pages 8-9).

Philosophically, it also tells us that it is next to impossible to divine the true state of the macroeconomy, much as The Absolute is unfathomable through rational methods of enquiry!

This is relevant to the current debate on India’s 3Q2016-17 GDP growth estimate where some inappropriate comparisons to China have been made. That is silly. In China,there is an official systematic attempt to mis-state GDP. In India, it is still about methods and not mala fide.

Take, for example, this paragraph on inflation calculation in the United States and Japan, from the same source cited above. Whether the country is in the throes of inflation or not is captured by how the statisticians account for rental costs:

The rental component in Japan probably understates inflation whereas, of course, in
America rising rents have been the key upward driver of reported core CPI inflation. This is because in Japan there is no allowance made for the depreciation of housing in the rental component whereas the opposite is the case in America. Thus, Tokyo CPI for rents, accounting for 24.5% of the Tokyo core CPI basket, declined by 0.6%YoY in January (see Figure 13), contributing an estimated negative 15bp to Tokyo core CPI deflation. By contrast, US shelter CPI, which accounts for 42% of the core CPI basket, rose by 3.5%YoY in December while core CPI rose by 2.3%YoY. Excluding shelter costs, US core CPI rose by only 1.3%YoY in January.

News that matter

American politicians and intelligence agencies are making too big a deal out of their claims that Russia interfered with their elections. Their interference in democratic processes in other countries is well known. Russia could not have influenced the vote. This comes across – whether intended or not – as an attempt to cast aspersions on the legitimacy of the victory of President Trump. This blog post by a blogger Michael Kreiger of the Liberty Blitzkreig blog is an important read.

Incidentally, Mr. Michael Kreiger has good posts on Trump’s cabinet picks. Read them here. They are critical observations and legitimate too. They echo my observations in my recent MINT column:

Indeed, whether the swamp is drained or allowed to remain would be very much determined by the actions taken with respect to the financial sector. Reining in financialization is the key to tackling income and wealth inequality and distortions caused to the real economy by debt (leverage, in general) and leverage-backed surges in asset prices. [Link]

Of course, in my MINT column, I had referred to a Wall Street Journal article that mentions that Trump appointees favour a higher bank capital ratio. That is a good thing.

Indonesia has chastised and cut off business with JP MOrgan for the latter has downgraded Indonesian sovereign bonds to underweight. Some wrote that the Indonesian stock market had been downgraded. I do not think that is right. In either case, it is an over-reaction. Needless. Only if there is a clear case of malintent as was between Morgan Stanley and Kazakhstan, then there is a need for governments to react. The former accumulated CDS on Kazakh bonds and worked to trigger a credit event. Read Gillian Tett commentary in 2009 on this.

When governments do this, they  attack the analysts’ integrity and independence. Then, when they do the same with stocks, governments lose their moral rights to pull them up or punish them in the name of good governance.

Apple deferred to China and pulled New York Times from its app. in China. It could not have happened to a more objective and balanced newspaper (?!)

China has further tightened the screws on foreign non-governmental organisations operating in China:

The legislation requiring the China offices of charities and foundations to find an official sponsor and file regular and detailed activity plans to the police is seen as one of the ways the ruling Communist party intends to cement its rule by asserting control over a burgeoning civil society.

China’s Ministry of Public Security (MPS) waited until last week to publish a list of eligible sponsors, meaning that almost none of the thousands of foreign non-profits in China — ranging from charities such as Greenpeace and Oxfam to funds such as the Ford Foundation — will meet the law’s conditions before the January 1 deadline. [Link]

This is a sequel to what was done last April.

In an article peppered with unverified and anonymous comments, FT writers blame Brexit and Theresa May for China cooling off towards Britain. For all we know, it might be a good thing for Britain.

Further, China is squeezing South Korea hard because it had chosen to deploy a US missile defence system on its soil:

China has threatened some of South Korea’s largest companies over Seoul’s decision to deploy a US ballistic missile shield, according to several people briefed on the conversations.

Samsung and Lotte Group were among companies warned by a foreign ministry official during a visit to Seoul last week that their China business could suffer because of the Korean stance.

South Korean officials labelled a visit by Chen Hai, the ministry’s deputy director-general of the department of Asian affairs, as “highly irregular”. They said he ignored requests to postpone the trip until the new year and did not pay a courtesy call to his counterparts at the foreign ministry in Seoul. [Link]

One would have thought that this would bring South Korea and Japan closer. Is it bad diplomacy or is it a case of bad times for South Korea? Apparently, a non-governmental organisation set up a statue of a ‘comfort woman’ outside the Japanese consulate in the port city of Busan. Japan has recalled its Ambassador to Seoul. May be, who knows, some NGOs are still useful for Beijing?

May be, I am repeating it. This news about Indonesia is important too. The title of the article is appropriate. May be, this is justification enough for JP Morgan downgrade?

I wonder about the presumptive logic of the inevitability of Asian rise in the 21st century.

PM Lee speaks to TIME

Two weeks ago, there was a very insightful interview of PM Lee Hsien Loong of Singapore by Ian Bremmer for TIME magazine. You can read it here. PM Lee has couple of positive references to India; explains why Singapore has not opted for Universal Basic Income and refuses to condemn or praise China’s leadership. He says that America abandoning TPP would not enhance its prestige and that PM Abe of Japan had staked a lot to get it done, from the Japanese side.

PM Lee rejects the ‘America on a downhill slope’ hypothesis:

I am very reluctant to say that America is on a downhill slope. You currently have difficulties, both with the economy and the politics, which is very fractious. But it is not to say that the Chinese do not have their own problems or that America does not have a lot of resilience, creative energy and entrepreneurship. You have the science, you have the technology in Silicon Valley and you have the ability to attract brains from all over the world. You can bounce back. On a 15, 20 year view, I do not see any reason to believe that you will continue to go downhill.

He is very correct. But, the sad part is that Americans do not believe it. The crisis has hurt their morale than their economy more. In the final analysis, that is the worst damage that the crisis might have caused America. Look at this remark by Ian Bremmer:

China is responsible for 37 per cent of global growth right now. And certainly, everyone I talk to in the White House understands that if it were not for China after the 2008 financial crisis, we would be in a very different position than we are right now.

Frankly, America held and holds more aces than China does. China could not have afforded to sell down U.S. Treasuries. I had blogged on it here, yesterday. In fact, China panicked after 2008, very badly. Hence, the massive credit stimulus. That is going to hurt them very badly. In a sense, the crisis has extracted its price and it is still extracting. America is psychologically damaged (lower self-esteem) and so is China (more hubris). But, America is less financially vulnerable than immediately after the crisis, whereas China is more so.

Therefore, on balance, China is worse off from the 2008 crisis.

In response to a question whether China is the only option if American pivot to Asia is deemed to have failed, PM Lee gives a very insightful reply:

My question is if it turns out that the United States’ pivot to Asia is seen to have failed in the next five to ten years. Do you think that the only real alternative is that China becomes the dominant player in the region or do you think that we are evolving towards a much more multilateral situation?

It depends on what the Indians do, what the Japanese do. India’s scale is not as massive as China, in terms of their gross domestic product (GDP) or their trade. The Chinese are three times their GDP, but India is growing. Mr. Modi is trying to set the country in the right direction and they will have interests beyond the South Asian subcontinent. They have a complicated relationship with China. There is a border problem and there is rivalry. It depends how they participate in the region. I think their interests will push them to be more active, but we will have to see how that goes. The Japanese, if the Americans begin to look less reliable as a partner, you do not know what they will do. Their Cabinet Secretary has already said in February this year that nuclear weapons are not against their Constitution.

In effect, he says NO; there are alternatives. He hints at the possibility that Japan has the nuclear card and he does not rule out India. Indian leaders should read this Jamil Anderlini piece in FT for starters and makes their moves with ASEAN. China is not importing much from ASEAN these days.

Further, despite the massive economic interaction between China and America – which is different from the cold war era relationship with the Soviet Union, he points out that there is lack of ‘strategic trust’ between the two.

He also believes that China will have to move towards more Federalism more quickly than they have so far and that he sees problems in it while he believes that PM Modi in India is making genuine progress with it in India.

On China’s federalism prospects:

Their society is changing, they need mechanisms that will work with the new generation. Otherwise, if young people become disillusioned, and opt out or become fractious, it is very troublesome. It is a big country, you may think they have full control but actually it is very hard for them to maintain control. Things happen which they do not know about, and they are extremely nervous about it.

His comment on the Internet and the silicon valley types are very interesting and valid. On the latter, pl. read the interview. On the Internet, this is what he said:

It is a tool which you have to use. When the Internet came, people thought it was marvelous. Now, everybody can speak. But the actual result is to the extent that everybody can speak, you get a lot of strange stuff on the Internet. Yet, on the other hand, to a great extent, people go on the Internet to access half a dozen major services. Google, Facebook, news sites, I suppose entertainment, porn. That is about it. It is not as if there a million different masterpieces in a library and you explore a new treasure every day. It did not turn out like that. Human societies are not like that.

In fact, there is a message in it for the techno geeks and techno-optimists. What you envisage and how it turns out, in reality, could be far different, far unpleasant and far short of the ideal.

I repeat: the whole interview is worth reading.

GDP revisions

Bank of Korea is revising lower the Korean GDP growth forecast. Small revision from 2.8% to 2.7% and inflation forecast from 1.2% to 1.1%.  [Link]. Korea’s policy rate stands at 1.25%.

Japan’s gross domestic product will expand by just 0.9 percent in the fiscal year that started in April, compared with a January estimate of 1.7 percent, the Cabinet Office said. The consumer price index will rise 0.4 percent, compared with an earlier projection of 1.2 percent, it said. [Link]

In a supplement to its annual Article IV report published Monday, the IMF estimated Italy’s economy to expand by just under 1% this year, down from a forecast of a 1.1% growth originally published in May.

For next year, the IMF revised its growth forecast for Italy to roughly 1%, from 1.25% previously. The new forecasts are preliminary and final data would be published next week, the IMF said. [Link]

In the light of Brexit, IMF has revised down growth forecasts for the UK, for European economies and for the global economy as well. [Link – may be behind a paywall]

The July 2016 World Economic Outlook Update of the IMF can be downloaded here.

Tell this to the global stock market investors.

June 2016 – monthly market commentary

June was the month Brexit happened. British voters voted to leave the European Union. Therefore, one has to calculate market returns before June 23 and after June 23. Predictably, European stocks bore the brunt of the shock result. MSCI Europe dropped 6.5% in USD terms for the month. S&P 500 index was flat for the month at 0.26% as the index rallied in the last few trading days of the month. Japan stocks, as the country struggles with both growth and deflation, were down 3.2% in the month. Emerging markets had fared better. Asia ex-Japan stocks netted a gain of 2.75%. India was up 1.04%. China stocks fared slightly better with a gain of 1.24%. Brazil, one of our favourite markets, was up 19.5%. Russia was up 2.5%.

WTI crude price was down 1.6% during the month. As risk aversion picked up among investors, the price of gold went up 8.8% during the month with the bulk of the gains coming post-Brexit. The overall S&P Goldman Commodities Total Return Index was flat for the month. Unsurprisingly, US Treasury bonds posted gains in the month. They were up 2.8% whereas European sovereign bonds were up only 0.7%.

Brexit was not a trigger but a reminder of the fraught political and economic world. Increasingly, financial markets will reflect that reality in the second half of the year.

Weekend reading links – 21.05.2016

Europe

An analyst thinks that Deutsche Bank’s problems are insurmountable

In Florence, Italy, the top earners among the current taxpayers were found to have already been at the top of the socioeconomic ladder six centuries ago.

German law professor suing ECB to stop QE; warns of legal surprises in coming weeks

Western nations realise that low rates do not create inflation. Some of us understand why but most don’t want to know.

Britain/Brexit

Former London Mayor Boris Johnson invokes Hitler as debate over Brexit debate heats up. David Cameron invokes Churchill in arguing against Brexit.

Allister Heath of Telegraph on why he would vote for Brexit. A good read.

India

Andy Mukherjee questions India’s myopia in blocking foreign banks taking stake in Indian privately owned banks.

MINT writes an edit on the shifting balance of power in favour of judiciary in India. Not a good development.

Janmejaya Sinha suggests a roadmap for creating a globally weighty banking system

Mukesh Butani in MINT calls the Modi government glass more than half full, at the end of two years.

MINT uses statistics to show that fewer A-rated movies are made in India but that censors are still demanding ever more cuts. Is that so?

A new Little India in New York.

HSBC to cut branches in India almost by half.

Anil Padmanabhan in MINT questions the Election Commission’s show-cause notices to the two major political parties in in Tamil Nadu on their populist poll promises. He is right.

Tunku Varadarajan makes a brave attempt to understand a Supreme Court judgement text in India. But, Andrew Haldane of Bank of England at least, admits to the problem of verbosity and incomprehensibility (oops! That is quite long)

America

Rana Foroohar of TIME voices her concern over financial engineering by US corporations

U.S. Senate passes legislation that would allow individual families to pursue Saudi government officials for 09/11. America revealed that Saudi Arabia holds about USD116bn of U.S. Treasuries.

Life expectancy for top 1% and bottom 1% diverge greatly in the US (news from April)

Only one tech. company has done IPO this year in the US.

U.S. corporate balance sheet concerns – a good read

CIA ‘mistakenly’ destroys copy of a 6700-page torture report.

G-7

Wall Street Journal says that the US and Japan are heading for a stand-off on yen devaluation. America’s objections are hard to fathom

G-7 disunity over a country that was not present in Tokyo

Is there really someone in charge in G-7?

Global/General

World Bank decides to abandon use of the distinction between ‘developed’ and ‘developing’. Plus, lots of other useful information

‘Atlantic’ magazine discusses if there is free will. No mention of Lord Krishna who resolved the dilemma neatly several millenniums ago.

Google’s AdSense places advertisements of multinationals on a jihadi website

This says it all: “Not only did we just experience the hottest April in 137 years of record keeping, but it was the 12th consecutive month to set a new record…. So far, 15 of the hottest 16 years ever measured have come in the 21st century.” – so, it is not just about El Nino.

Martin Sandbu on the Western double standards on corruption in developing economies. He gets it right.

Entries for this year’s photographs of the year contest for the National Geographic magazine.

One macromolecule to kill all viruses – in the works

Michael Lewis reviews Mervyn King’s book – both are MUST-READs.

Gold and Oil

Goldman says oil glut has vanished (for now).

Bloomberg says that gold surge signals waning confidence in central banks

China

Chinese banks operate at the margin between regulated traditional banking and lightly regulated financial services.

China City Construction Holding Co. wants the People’s Bank of China to provide debt guarantee.

China’s industrial production, retail sales, fixed asset investment for April miss analysts’ estimates. How can it be?

Zhang Dejiang assures Hong Kong it will not be absorbed by mainland China

The US has paved the way for the imposition of duties of as much as 500 per cent on Chinese cold-rolled steel, used to make cars and washing machines, as a backlash escalates against a glut of Chinese steel flooding global markets.

A ‘Global Halal Park’ in China?

The European Parliament passed a non-binding resolution urging the European Union not to grant market economy status to China. China, by no stretch of imagination, is a market economy.

Apparently, China creates 488 million fake social media posts a year to distract critics of China.

China’s desire for headline growth may hide longer-term risks, says Moody’s. Phew! We did not know that.

China is ready if the United States stirs up conflict in South China Sea. Earlier, Pentagon reported an unsafe China interception of a routine air patrol in international air space and Pakistan’s General Sharif visited Beijing during the week.