Grant's Interest Rate Observer on the Downgrade of China's Sovereign Credit Rating

When you’re chewing on life’s gristle: don’t grumble, give a whistle!

Standard & Poor’s overnight downgrade of China’s sovereign credit rating (to A-plus from double-A-minus) hasn’t exactly fomented mass panic.  A sampling of cheerful reactions:

“Largely a non-event from a market perspective. I don’t think it will have an adverse impact on the sovereign issue or on the future borrowing of corporates.” – Todd Schubert, head of fixed-income research at Bank of Singapore.

“Moody’s [which downgraded China to A1 from Aa3 on May 24] was the first mover and we all remember spreads squeezed back in. So S&P just played catch-up to Moody’s and we expect marginal impact on spreads.” – Antonio Cailao, director of Asian credit trading at ING Bank NV.

“S&P’s is more of a catch-up rating action. There should not be much impact on credit markets. A+ is still a solid investment grade rating. There is no material information in S&P’s release that the market was not already aware of.” – Neel Gopalakrishnan, senior credit strategist at DBS Group Holdings Ltd. 

“The impact on Chinese asset prices will probably be on the upside. Large state-backed funds will probably buy rather than sell Chinese bonds and stocks.” – Ziyun Wang, a founding partner at DeepBlue Global Investment Ltd.

“The news could read positively in China. Domestic investors may expect the government to release supportive policies to ease any disruption.” – Qin Han, chief bond analyst at Guotai Junan Securities Co.

“Chinese fund managers are likely to sit tight on their positions. It would be a good opportunity to buy on the dip.”  -- Qiu Zhicheng, strategist at ICBC International Research Ltd.

“Why S&P’s First China Downgrade Since 1999 Is Good News for Bulls” – Bloomberg Headline. 

“Today’s downgrade means one fewer time in the future that China can be downgraded.  Bullish!” – Grant’s Interest Rate Observer.

In fairness to the carefree cavalcade, recent sovereign downgrades have in fact marked favorable entry points.  Moody’s May downgrade of China was followed by a 10% advance in the Shanghai Composite Index, steady action in the Chinese 10-year bond yield and, until recently, an appreciating renminbi/dollar exchange rate. Stateside, the 2011 S&P downgrade of U.S. sovereign debt hardly interrupted the downward march in Treasury yields, while the major equity indices rebounded from a short but steep correction to more than double in the interim six-plus years. 

Back in the here and now, S&P’s rationale for the ratings move centered on China’s heavy and fast-growing debt load, with the agency writing that the downgrade, “reflects our assessment that a prolonged period of strong credit growth has increased China’s economic and financial risks.”  

The report singles out mushrooming banking sector liabilities as a particular source of concern. Indeed, Chinese banking assets exceeded RMB 243 trillion ($36.9 trillion) at the end of the second quarter, up by more than 11% year-on-year and 300% above their levels at the time of the Lehman Brothers bankruptcy.   That foots to about 311% of trailing four quarter economic output of RMB 78 trillion ($11.8 trillion).