China’s Downgrade and the Case for Global Ratings Reforms

China’s Downgrade and the Case for Global Ratings Reforms

photo: PID

In March, the leading credit agencies cut their outlook for China’s sovereign credit rating from stable to negative. If the decision was warranted, it may also be time to reassess the current ratings of most advanced economies and accelerate global ratings reforms.

Standard & Poor’s (S&P) downgrade followed a similar measure earlier in March by Moody’s, another major ratings agency. S&P did maintain the rating AA-, adding that China’s reform agenda is on track, though likely to proceed more slowly than expected.

Nonetheless, the downgrade was strongly criticized by Chinese officials and media outlets. As a Xinhua commentary put it, China’s economic growth is decelerating amid a painful transition. However, a downgrade of outlook is not warranted as “the fundamentals of the Chinese economy remain sound and solid, and are improving.”

Was the downgrade warranted?

Rising criticism against credit agencies

Credit rating agencies (CRAs) assign credit ratings, which rate a debtor’s ability to pay back debt by making timely interest payments as well as the likelihood of default. The issuers include companies, special purpose entities, non-profit organizations, but also sovereign nations, state and local governments.

In the past two decades, the criticism of the leading CRAs has increased in the advanced economies, starting with the internet burst of 2000-2001, the subprime mortgage crisis after 2005, the global financial crisis in 2008-9 when hundreds of billions of securities that had the CRAs’ highest ratings were downgraded to junk, and the European sovereign debt crisis since spring 2010 when Brussels blamed rating downgrades for crisis escalation.

From huge energy companies, such as Enron, to Wall Street’s financial giants, the credit agencies – so it seems – have looked the other way, when the world’s largest financial conglomerates have engaged in excessive risk-taking.

As the major advanced economies no longer fuel global growth, large emerging economies – China, India, Russia and Brazil, among others – play an increasing role in these prospects. In these economies, criticism against the large ratings agencies has also increased since the Asian financial crisis of 1997-98 and the recent downgrades, which reflect substantial capital outflows and other challenges.

In advanced economies, criticism focuses on the CRAs’ professional conduct. In emerging and developing economies, it also addresses the issue of fairness. As the past two decades suggest, the CRAs are not immune to professional biases, moral hazards and conflicts of interests. According to critics, the problem stems from the extraordinary concentration of the CRA industry. 

The global might of the “Big Three”

According to influential reports in the early 2010s, the two largest U.S.-based CRAs – S&P and Moody’s – controlled some 80 percent of the global market share. In turn, the “Big Three” – S&P, Moody’s plus Fitch Ratings, which is dually headquartered in

the U.S. and the U.K. and majority-owned by a French holding company – dominate 95 percent of the ratings business across the world. Not only is the industry concentrated, so is their geography.

In both advanced and emerging economies, governments borrow money by issuing government bonds and selling them to private investors, overseas or domestically. However, emerging and developing economies enjoy neither the history of capital accumulation nor the high living standards that most advanced economies take for granted. Consequently, their efforts to borrow are far more challenging and constrained.

Yet, current credit ratings are based on advanced-economy CRAs’ perceptions of a sovereign’s ability and willingness to repay its debt. Of course, emerging and developing economies can seek funds from international multilateral organizations, such as the World Bank and the International Monetary Fund. However, the latter reflect the interests of their primary owners in advanced economies, which select their leaders, set their policies and control enforcement.

It is precisely for this reason that emerging economies led by China have recently established new alternatives, such as the BRICS New Development Bank (NDB) and the Asian Infrastructure Investment Bank (AIIB), which stress borrowing in the emerging and developing world.

Nevertheless, the “Big Three” continue to dominate the ratings business. 

Sovereign ratings and sovereign debt

Currently, China’s sovereign debt is adversely impacted by local debt, not by the central government’s debt. It is not the result of a long historical process, which is the case in the advanced economies. Rather, most of it was accrued as an unintended side-effect of the large stimulus package of 2009. The latter did sustain confidence amid the global crisis; it contributed to infrastructure in China; it spared advanced economies from the Great Depression 2.0; and it enabled global growth at a time when the latter was most desperately needed.

Yet, it also resulted in excessive, inadequately managed liquidity, which generated huge challenges in property markets and local debt. So, the government has engaged in a balancing act and structural reforms that seek to defuse the debt challenge in the medium-term, while ensuring adequate growth in the short-term.

If the “Big Three” see China’s downgrade as warranted, that raises the question whether the ratings of most advanced economies remain justified.

Without effective growth, major advanced economies rely on ultra-low interest rates (U.S.), continued quantitative easing, or both (Europe, Japan). Despite their high credit ratings, these economies have high, even excessive government-debt-to-GDP levels, as evidenced by Japan (close to 250 percent), Italy (over 130 percent), U.S. (105 percent), France (over 95 percent), U.K. (90 percent) and Germany (over 70 percent).

Toward global ratings reforms

The assumption is that these sovereigns are able and willing to repay their debt. Yet, despite the deleveraging rhetoric, in most cases the debt burden is actually increasing.

Japan’s rating is AA- (the same as China’s), even though its debt burden is twice as large in relative terms as that of Italy, which S&P has downgraded to BBB-, the closest to junk. The U.S. rating is AA+, although its debt burden in relative terms is significantly higher than that of France whose rating is AA.

The U.S. debt burden exceeds $19.2 trillion, which means that the nation must pay $2.4 trillion in total interest – more than the largest budget items (Medicare/ Medicaid, social security and defense) together. America also lacks a credible, bipartisan and medium-term debt-reduction plan, which would seem to contradict the S&P requirement that a country is not just able but willing to pay its debt.

Finally, the U.K. and Germany continue to enjoy AAA ratings – although their public debt level is in relative terms twice as high as that of China.

Since the global financial crisis, the Chinese credit rating agency Dagong has downgraded its U.S. rating several times. Meanwhile, U.S. Securities and Exchange Commission (SEC) in 2010 rejected an application by Dagong to enter the U.S. marketplace. In the advanced economies, the argument is that Dagong reflects Chinese interests. Yet, the argument that the “Big Three” reflect the interests of major advanced economies is discounted in advanced economies.

Unlike the large CRAs, Dagong and China are committed to reshaping the global credit rating system. Over time, that is very much in the interest of the international community. Consequently, these reforms are supported by a rising international consensus. Global sovereign ratings are far too important to remain a monopoly reserve of a few major advanced economies whose high-level debt poses a rising risk to global stability and prosperity.

Dan Steinbock is the founder of Difference Group and has served as research director of international business at the India China and America Institute (U.S.) and as a visiting fellow at the Shanghai Institute for International Studies (China) and the EU Centre (Singapore). For more, see  

The original version was released by, the official government portal, on April 13, 2016.