China's Sovereign Credit Downgrade

Nicholas R. Lardy explains that the downgrade of China’s sovereign credit rating will have minimal economic impact.
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Eitan Urkowitz: China's sovereign credit debt rating was recently downgraded. Joining me is Nicholas Lardy, senior fellow at the Institute to discuss the economic significance of this. So Nick, thank you for joining me.

Nicholas Lardy: Thank you.

Eitan Urkowitz: So why was China's credit rating downgraded?

Nicholas Lardy: Well, Moody's cited the fact that credit growth has been extremely rapid in China over the last three or four years. And they fear that even though growth of credit is slowing down a little bit that credit to GDP will continue to rise for the next several years. And this creates financial risk. So they thought a downgrade was in order.

 I mean quite frankly they could have done this, six months ago or a year ago. This very rapid growth of credit has been very well known in the market.

Eitan Urkowitz: So nothing materially has actually changed in China to spur this downgrade?

Nicholas Lardy: I think that's a correct assessment, I guess. So you would have to say though they think this credit growth relative to the size of the economy is likely to continue and that led them to the downgrade.

Eitan Urkowitz: So what's the economic significant of the downgrade?

Nicholas Lardy: I think the economic significance is actually fairly minor. China does not actually depend on external buyers of its debt. Foreigners only hold about 1.2 percent of all the Chinese bonds outstanding. So they're selling almost all of this debt in the internal market. And the internal market will pay very little attention to the Moody's rating.

Eitan Urkowitz: So what can China do to restore its rating with Moody's?

Nicholas Lardy: Well if you believe the statement that they put out, they'll be looking for some movement towards stability in the ratio of debt to GDP. If China was on a trajectory to achieve that and nothing else changed, you would have to assume that they would raise the rating back up.

Eitan Urkowitz: So moving quickly to the economic reforms in China, is this going to have any impact on that or is this going to change the pace of China's reforms?

Nicholas Lardy: Well, I do think it's kind of a wake-up call. Maybe if the financial system and the leadership in China haven't really focused on the debt problem, the external downgrade certainly brings it forcefully to their attention. I think in fact they are well aware of it. They have been taking steps to slow the growth of credit, and the credit growth has slowed quite a bit over the last six or seven months.

Eitan Urkowitz: Thank you, Nick.