Fitch Could Downgrade the Sovereign Rating of China

While the European Union and the United States are buffeted by a debt crisis without precedent, Thursday, rating agency Fitch said it may lower the sovereign rating of China in the next two years for the heavy debt of the Chinese banking sector, which having provided massive loans in recent months.

In an interview with Reuters, Andrew Colquhoun, head of Asia Pacific at Fitch ratings, has considered a possible downgrade of China in 12 to 24 months. “We anticipate a deterioration in the quality of bank assets. If the problems of the sector are changing as we anticipate, or even worse, in the next 12 to 24 months, this would lead us to lower the note,” he warned.

Last April, Fitch already lowered its rating outlook for China from “stable” to “negative”, citing concerns on the financial stability of the country following the decision of Beijing to increase bank credit to maintain China’s economic growth.

Currently, Fitch assigns the note of China to ‘AA-‘, corresponding to the fourth highest level of its scale, position equivalent to that of Italy and a notch below that of Spain.

In early July, the rating agency Moody’s had indicated that the public debt of China stood at 36% of Gross Domestic Product (GDP), taking into account of local governments for which Beijing assume direct responsibility.

A few days earlier, the National Audit Office had indicated that the debts of the provinces, municipalities and districts in late 2010 rose to 27% of Chinese GDP, representing a total of 1.62 trillion U.S. dollars.

The same office had, however, insisted that 63% of this debt would be repaid through revenue budget.

But some of these debts, might threaten the banking system. The Credit Suisse sees it was the biggest “time bomb” for China’s economy.

The Chinese government estimates for its public debt to around 20% of GDP. But it does not include in its calculation the financial elements of local governments, which are not allowed to borrow directly, now they have borrowed huge amounts from the global financial crisis, via means of ad hoc structures called “platforms financing” to finance infrastructure and housing projects which are not always profitable.

According to the National Audit Office, the “ability to pay is low and faces potential risks in certain areas and certain industries.” Indeed, in a snowball effect, some local governments had to make new loans to repay the debts already contracted, also heavily dependent on land sales to meet their deadlines.

According to the auditors of governments of China, 108.3 billion yuan of loans were made or used fraudulently, the money ends up in banks, stock markets or real estate.

“The debts existed before the global financial crisis, but they quickly accumulated in the last two years while investment by local governments has been used as a key tool” to boost the economy, said Moody’s.