In China’s Credit Ratings, Democracies Pay a Price
The U.S. trade war with China is morphing into an all-out economic conflict between the world’s two largest economies. Some worry that China could open a new front by dumping U.S. Treasurys or devaluing the renminbi or could hamstring U.S. military hardware by cutting off the supply of rare earths. But there’s one possibility nobody has considered: a ratings war, where China tries to persuade the world to take on its own assessments of sovereign debt.
That’s mostly because no one takes China’s credit ratings seriously, least of all Chinese debt issuers and investors. But although the prospect of dueling ratings isn’t likely anytime soon, some countries are increasingly comfortable with the Chinese rulebook.
China’s distinctive credit rating system offers a transparent window into what a world run according to the norms of the People’s Republic would look like. The view is crystal clear yet deeply unnerving: It would be a lot costlier for democracies and their citizens—and a lot more comfortable for autocrats and kleptocrats.
The power of ratings
Credit ratings emerged in the early 20th century as a way for investors to understand the risks associated with stocks and bonds. The simple rating scale, which is topped by the famous “AAA,” or triple A, is meant to indicate how likely issuers are to default on their debt obligations. A higher rating means lower risk, which translates into a lower interest rate issuers need to offer investors.
Moody’s Investors Service, Standard & Poor’s (S&P), and Fitch Ratings, which pioneered the ratings industry, all began by rating stocks and corporate bonds. Moody’s was the first to rate a government bond in 1918, but S&P issued the first “sovereign rating” in 1941, when it gave a AAA rating for the credit worthiness of the U.S. federal government as a whole. But the number of countries receiving sovereign ratings did not expand substantially until the late 1980s, after the debt crises of the 1970s and early 1980s had passed. Today, Moody’s has the widest coverage, with 135 sovereign issuers, followed by S&P with 131, and Fitch with 109.
The power of ratings comes from the reputation of the ratings agencies for having a consistent record of accuracy but is backed up by U.S. government regulation. In the mid-1970s, the U.S. Securities and Exchange Commission started licensing raters, and other U.S. laws mandated that investors are only permitted to buy debt rated highly by these agencies. The size and importance of the American debt market turned this national oligopoly into a global one. The regulatory stranglehold of the top agencies was lifted in 2010, with the Dodd-Frank financial reforms, but the investment community still depends heavily on ratings.
As a result, the monetary authorities of governments the world over have a love-hate relationship with the agencies because their verdicts can save or cost them billions of dollars in interest payments. No government has ever complained of being rated too highly, but they often gripe about being disrespected and misunderstood with low ratings.
China’s industry
A small number of other rating agencies have emerged in the shadow of the Big Three in the United States, Europe, and Asia. They primarily focus on niche markets that draw on their familiarity with specific economic and political circumstances. China’s ratings industry dates to the early 1990s, when liberal reformers determined that for China to have a modern financial system it would have to develop its own bond market and rating agencies. One of the first was the nonhumbly named Dagong Global Credit Rating. (Dagong means “great commons.”) Like others, its first decade was nondescript, as China’s bond market was tiny, opaque, and totally state-controlled. Investors were barely aware of these agencies’ existence.
By: via @AlliesFin Serve T.ME/ALLiESFiN
