Chinese financial markets were stunned this morning to wake up and see that Moody’s downgraded China. Now I think there are numerous things that are important to note about what this means and what it does not mean.
- Given the near perfect closure of the Chinese financial markets it will have no impact on its ability to issue government debt or the price it will pay to issue that debt. In a very fundamental way, it has no impact at all.
- It does matter in its quest to attract foreign capital. China has been trying really hard, advertising, and opening the door further and further to try and get foreign capital to come to China. Other than CBs holding relatively minimal amounts of bonds, there simply is not much international investor interest and a lower rating is not going to help. As I have noted before, the entire Chinese economic and financial model relies fundamentally on large net inflows. Given the index nature of large investment flows today, mandated funds will flow in fixed income will flow to what fits their mandate. Lowering the credit rating of the Chinese government will prevent large amounts of mandated fixed income capital from flowing into China especially if MSCI adds China to some of its indexes.
- It is also a real psychological blow. If you have been following the Chinese financial markets lately, you understand how stressed they are behaving. With surprising regularity, senior politicians and regulators have stressed how there are no risks of defaults, liquidity problems, or hard landings. For a technocracy which is so used to speaking in riddles, this is a stunning degree of frankness and shows you what they are responding to within the Chinese population. It is clearly noted in Chinese media and not that there is a sense of panic but the mood does not feel like people feel like the economy is going strongly. I honestly can’t think of another economy or financial system where politicians so regularly paraded before the press and said things like no systemic risk, solvent industry, and discouraged talk of hard landings. If this happened anywhere else people would be certain at least one of these was about to happen. This speaks to the psychological state of the Chinese economy and investor.