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Business NewsHome > Business > Business News
Monday, 29 May 2017
China downgrade points to concerns over long-term financial stability
BY YAP LENG KUEN
THE surprise downgrade of China’s sovereign rating by Moody’s, the first time in 30 years, may not have a major impact on markets but points to nagging concerns on its long-term financial stability.
“It is unlikely to trigger a material impact as it is still an investment grade. But China needs to reduce its bloated debt to a sustainable level as that is seen threatening the stability of its financial sector.
“While the authorities have taken a series of measures to reduce debt, more needs to be done before it spirals out of control,” said Lee Heng Guie, executive director, Socio Economic Research Centre.
Moody’s downgraded China’s sovereign ratings by one notch to A1, as it expected the financial strength of the world’s second-largest economy to erode in coming years on slower growth and mounting debt.
China strongly criticised the downgrade, that it was based on “inappropriate methodology”, exaggerating difficulties facing the economy and under-estimating the government’s reform efforts, noted Reuters.
Structural reforms in China will slow the pace of its debt build-up but will not be enough to arrest it, and another credit rating cut is possible unless it gets its ballooning credit in check, said Reuters, quoting officials at Moody’s.
After Moody’s downgrade, its rating for China is on the same level as that of Fitch Ratings, with Standard & Poor’s still one notch above, with a negative outlook, said Reuters.
No major impact
“The downgrade may lead to higher offshore funding costs for Chinese firms but may not deter these firms from investing offshore.
“There is still upside for emerging markets with higher inflow of funds driven by risk-on sentiment and (expectation of) potentially higher corporate earnings,” said Danny Wong, CEO, Areca Capital.
“Equities seem more focused on the possibility that the US Fed may raise interest rates further, pointing to a still robust US economy,” said Chris Eng, head of research, Etiqa Insurance & Takaful.
“Since the beginning of the year, the MSCI emerging markets index has been climbing as the US dollar index is weakening.
“China is only part of the emerging markets universe and funds still look at other emerging markets,” said Pong Teng Siew, head of research, Inter-Pacific Securities.
In currencies, the yuan strengthened despite the Moody’s downgrade as China announced it was considering changes to the way it calculates the currency’s daily reference rate against the US dollar.
That move is likely to reduce exchange rate volatility and give the authorities more control over the fixing while restraining the influence of market pricing, said Bloomberg.
China seems determined not to play into the hands of short sellers (betting on further weakness of the yuan), noted Pong.
Fund destinations
The Asean valuation has hit a sweet level, said Maybank Kim Eng, adding that the MSCI Asean relative to MSCI China’s price-to-book (PB) valuation has fallen to near previous lows in November 2007.
The PB ratio is a ratio that compares the market value of a stock with its book value.
“Within Asean, we continue to favour long Indonesia, short the Philippines relative value trade. Malaysia has fallen to attractive levels.
“We have seen money continue to flow back to Asia, and should remain in the region even after the Fed raises interest rates.
“Year-to-date, the Asia dollar index has appreciated by 2.7%,” said Maybank Kim Eng in its report.
Given the deepening worries over US president Donald Trump’s erratic behaviour that is worrying global leaders and investors, money is expected to remain in Asia even after the Fed rate hike.
“Some funds are leaving the United States. The stronger ringgit points to that,” said Pong.
Some fund managers are talking of moving funds out of the United States for the next three to five years to other developed markets and emerging markets, noting the rise in some of their indices.
“India still looks good. Indonesia is good too although it has lost some of its shine lately,” said Pong.
Malaysia may be good for the next one to two years; a concern is that continuous infrastructure spending may result in sub par growth.
“Infrastructure spending is a function of pouring more resources into public works.
“There will be economic growth but there is no real attempt to ensure that inputs earn a return that is commensurate with returns elsewhere,” said an analyst.
“China may mostly sit out this rally although there may be star performers,” said Pong.
Worries of economic slowdown in China has intensified.
“China’s capital expenditure (capex) growth has declined sharply although this could be a one-off.
“In Asean, capex growth continues to improve after three years in decline,” said Maybank Kim Eng.
Europe seems a good bet.
“The president of the European Central Bank, Mario Draghi, is riding on a resurgence in Europe as he positions to extend quantitative easing (purchase of securities by central banks to, among other objectives, increase money supply),” said Pong.
For long term investments, fundamentals prevail.
“It may be tantamount to market timing if we just position for funds inflows.
“We advise our clients to have a diversified portfolio with appropriate asset allocation while we increase our exposure,” said Wong.
Columnist Yap Leng Kuen notes the need for selective investments.
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