Why is China building its own domestic credit rating architecture? – The diplomat


Pacific money

China has no intention of opening more than it needs.

As the international media focus on either the social ranking aspect of Party cadres of China’s new credit rating system or the policy of sovereign credit ratings, many have missed the more substantial development of credit rating agencies. Chinese credit rating and their battle to assess local government debt.

Rather than allowing foreign competition to improve its debt instruments, China seeks to institutionally strengthen its own credit rating system, by inviting foreign credit rating agencies into the system in order to attract technology transfers. in services. However, the deeper structural problems of China’s local government bond architecture are unlikely to be resolved by simply allowing U.S. companies to enter without deeper structural reform of local government debt instruments.

China’s recent opening of its domestic bond markets to the trio of US ratings Fitch, Moody’s and Standard and Poor’s will not mean better bonds. Foreign companies will still not be able to issue debt in China and the structural problem of local government bonds shows no sign of abating despite various accounting experiences such as central-local debt swaps, debt-for-equity swaps or expansion of debt asset management -cleaning model at the provincial level.

China has struggled with a local government debt problem and broader underlying central-local budget issues for about four decades. Under the system of line ministries of the managed economy, provincial and prefectural governments simply borrowed money from commercial banks for tax expenditures. It is quite an extraordinary accounting practice. Due to the financial crackdown on the Chinese deposit savings system, the network of commercial banks still functions as another form of taxation, and state institutions – both government and corporations – can simply contract debts. loans from state commercial banks for utility expenses.

The Chinese Ministry of Commerce and SASAC, the state asset regulator, have jointly overseen the development of national credit rating agencies since the reform of the banking system in the early 1990s. However, credit rating agencies have been largely ignored by both government and market debtors in the further development of Chinese capital markets. The state banking system offered such easy credit that there was no need for credit rating. And most of the external criticism of endogenous risk in Chinese capital markets has centered on the dominance of the banking sector or the nonperforming loan portfolios of these banks, without paying too much attention to the lack of institutional development of credit rating.

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Since it became clear that there is no credible plan to clean up the local government debt obligations that have accumulated over the past 20 years of investment-led growth, the desire to a viable credit rating system has emerged in central government political circles. However, the rating of local government debt is as sensitive as the opening of public markets, China has no intention of opening more than it needs. China is renovating its existing national credit rating system to strengthen the credit risk of bond issues by provincial, prefectural and municipal governments. At the provincial level, governments are empowered to develop a modal system to assess businesses and local governments, independent of central government.

Asset management companies are used to clean up existing provincial debt, replicating the model of the four asset management companies created to clean up the non-performing loan portfolios of the four state-owned commercial banks. The delegation of this model to the provincial level in 2016 saw a proliferation, with in fact a model established for each province, of veritable locks for the main government debt. But asset management companies are not private equity funds, and the closed loop of the Chinese bond system means there is no clean way to get rid of existing debt while new debt. local governments are constantly being fed into the system.

Wenzhou, Zhejiang, leads the local credit reform pilot projects with a prefectural-level asset management company and a well-developed provincial network of credit rating agencies. It is currently the political proving ground for a comprehensive national credit rating system which is expected to be rolled out by 2018. The local pilot in Wenzhou is organized under the “Construction of the Wenzhou Social Credit System 2016-2025 ”. Wenzhou itself is a progressive independent regime functioning more like a city-state. He benefited from the household liability reforms early on, but was later sent overboard to sink or swim as part of Zhu Rongji’s business reforms, resulting in the development of huge speculative bubbles in the private economy.

Developments in credit scoring in Wenzhou include the Local Development and Reform Commission which is developing a prefecture-wide credit blacklist and information-sharing platform to consolidate existing credit data into a single accessible platform. Wenzhou also lobbied to establish a local municipal government asset management company, despite national regulations limiting the asset management model to the provincial level of government. China Everbright Asset Management Company was approved by the banking regulator at the end of 2015, the first for a prefectural city. With 293 prefectural cities in China, all mired in local government debt, expect a bloom of asset management companies to hide past debt obligations and repackage them into creative “wealth management” products.

However, even if the new credit rating system were to effectively assess new issues of provincial and prefectural bonds, two huge problems would remain: the existing debt pool and the fiscal constraints of provincial and prefectural governments. Local government debt problems stem from unorthodox borrowing and off-budget accounting. New fiscal responsibilities and new revenue-sharing powers are now being rolled out to all levels of local government, but the changes are not deep enough to shift the structural issues from center-local tax arrangements, where local government loses most. of its tax revenue to the center, but are forced to hold all the risk of the bonds issued to cover the deficit between taxes and spending.

Opening up the Chinese credit rating market to international competition is good for the global economy. But the focus on reforming credit ratings in China should not be blinded by the red herring of Party social credit ratings or competition for sovereign credit ratings by US companies. Rather, the importance lies in the internal audit and the development of a vast Chinese credit rating system at the level of local authorities and local public enterprises. And unfortunately for the global economy, China’s local government credit rating system is likely to be as methodologically hollow as the current US rating system.

Tristan Kenderdine is Research Director at Advisory Future Risk and a PhD candidate in Political Science and International Relations at the Australian National University


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