Dagong Global Credit Rating Co., Ltd.
Dagong Global Credit Rating Co., Ltd., the world-renowned credit rating agency, has released its Global Sovereign Credit Outlook 2018 on January 17, 2018. The report makes an objective judgment concerning global credit rating trends given the fact that developed countries headed by the U.S. are commencing or accelerating the normalization of their monetary policy, while China makes major adjustments to its economic structure. This document marks Dagong’s eighth release concerning global sovereign credit rating since 2010, and it is designed to dedicate China’s wisdom towards safeguarding against global sovereign credit risks.
The U.S.-led developed countries’ move towards accelerating monetary-policy normalization and China’s major adjustments to its economic structure are the main factors which will exert an impact upon the trend of global sovereign credit rating in 2018. Heavily-indebted developed nations undergo increasingly divergent credit risks. The U.S. Federal Reserve’s rate hikes and balance sheet reduction and massive tax cuts will increase credit risks facing the country, thus constantly undermining its solvency. Japan and Italy, amongst other countries, face the possibility of eroding their solvency due to slow progress of structural reforms and lack of robust driving forces for economic growth; meanwhile, countries including Germany, Spain and Ireland, amongst others, will witness the remarkable results of fiscal consolidation, and government debt burden thereby enters a downward channel with solvency bolstered. Emerging markets and developing countries face dramatically increased sovereign credit risks as a result of several factors including China’s major structural adjustment, the Fed’s rate rises and balance sheet drawdown, growing trade barriers, and a reduced capability to guard against risks. Countries in Latin America, Central Asia, and Sub-Saharan Africa encounter increasing sovereign credit risks.
The prevailing trend of global sovereign credit rating in 2018:
Ⅰ. Political polarization and its ongoing expansionary fiscal policy will further jeopardize repayment sources of the U.S. federal government, which will increase sovereign credit risks at a faster pace.
In 2018, gradual rate rises and the country’s expansionary fiscal policy will increase the debt burden of the U.S. federal government. The Trump Administration’s combination of tax cuts, infrastructure construction, and rate rises, as well as a shrinking balance sheet, will all add to a more substantial federal fiscal gap. Given the apparent upward trend in inflation, Dagong determines that 2018 will witness three Fed rate rises with the federal funds rate striking a range of 2% to 2.25%. Due to uncertainties concerning the market’s appetite for treasury bonds, the following five years will see the Fed’s balance sheet decrease to around USD 2.1 trillion, while the progress of shrinking the balance sheet will be slower than the Fed’s anticipation. A tight monetary policy featuring the combination of rate rises and balance sheet reduction will immediately push up government financing costs. Interest payments grow at a faster rate, financial revenues fall owing to tax cuts, and the demand for infrastructure investment increases. Thus, the medium term will witness the federal government fiscal deficit go up while debt will go snowballing. It is forecasted that in 2018, the federal government debt burden will hit 106.6% and will slightly rise to 112.9% in 2022.
Unbalanced development of the country’s credit ecology, which has long been deviating from the law of value, causes an irrational structure of repayment sources, and leaves the U.S. federal government in the mire of taking on new debts to repay the old ones. Since 2008, the Fed had adopted quantitative easing to maintain the credit bubble. The federal government thereby sees growing dependence on debt monetization, which will not change soon due to the Fed’s rate rises. The federal government raised the debt ceiling respectively in March and September of 2017 and once again came to the verge of a fiscal cliff in December. Frequent debt ceiling rises suggest that U.S. government debt becomes unsustainable.
Ⅱ. The Chinese economy has undergone a bottoming process and structural reform, which had led government debt to continue climbing, although achievements of reform and enhanced growth quality will prop up China’s sovereign credit in the medium term.
To ensure substantive progress in supply-side reform, due to its proactive fiscal policy, China’s government debt will see faster growth in the medium term. 2018 marks the fortieth anniversary of China’s reform and opening-up as well as a decisive year in fulfilling the strategic goals of the country’s 13th Five-Year Plan, and therefore the Chinese government will continue advancing supply-side reform steadfastly. China’s central bank will maintain a prudent monetary policy and fiscal policy will continue playing an active role in implementing supply-side reform. It is projected that the Chinese general government debt burden will rise to 51.5% in 2018 and 56.8% by 2022.
China’s growing economic resilience and the government’s enhanced wealth creation ability will help reduce government debt risks, thus guaranteeing its solvency. The Chinese economy is entering into a new normality featuring short-term fall backs, long-term stabilization and ultra-long-term rebounding, while China sees slower yet better quality growth. The appropriate policy coordination is expected to balance multiple objectives and accelerate the long process of bottoming-out which is facing China’s economy. The Chinese government vigorously controls investment spending and shifts its finances to improve people’s livelihood and build a social safety net so as to achieve a beneficial interplay between economic growth and structural reform. In the long term, as China is finishing its economic restructuring, the medium term will witness China’s fiscal policy turn prudent and neutral, while government debt growth slows down and enhanced wealth creation abilities resulting from reform will offer enormous guarantee for China’s sovereign credit.
Ⅲ. Slow improvements in the external environment and serious vulnerabilities further increase the sovereign credit risks facing emerging markets and developing countries.
In 2018, sluggish foreign demand and tightened international liquidity will continue threatening the sovereign credit of emerging markets and developing countries. Global protectionism is on the rise and China’s economic restructuring leads the country to shift its economic driving force. Thus, export-oriented countries have to face the pressure of adjusting their export structure and shifting their growth engine to increasingly rely on domestic demand. At the same time, those countries become increasingly dependent on fiscal policy to develop their economy, and thereby their sovereign debt faces pressure from rapid growth. As European nations and the U.S. pursue quantitative easing, some emerging countries accumulate differing degrees of asset price bubbles and external debt risks. The Fed’s further rate hikes will cause global interest rates to rise and dollar-based assets to flow towards the U.S. at a faster rate. Thus, some emerging markets will face greater pressure from greater capital outflows, the downward trend of asset prices, as well as growing financing costs abroad. In 2018, due to deteriorating finances and reduced foreign exchange buffer, some countries in Latin America, Central Asia, and Sub-Saharan Africa will encounter an adverse situation where finances will worsen and sovereign debt risks increase, causing some countries to face the possibility of crises.
Ⅳ. The eurozone encounters high sovereign debt with increasing divergence; growing internal divisions and currency normalization add to the uncertainty over sovereign debt risks.
In 2018, sovereign debt in the eurozone will decline from a high level, although internal divergence will become ever more obvious. Growing political separatism and vulnerable credit bases render it challenging to fundamentally improve sovereign debt in the eurozone. The inconsistent pace of structural reforms among eurozone members will exacerbate the structural economic and political imbalance and increase difficulties in addressing sovereign debt. Thus, the eurozone will rely on ultra-loose monetary policies to stabilize sovereign debt risks. It is estimated that 2018 will witness the eurozone’s general government fiscal deficit decline to 1.3% and the general government debt burden to stand beyond 85%. Regarding France and Italy, since their respective structural reform lags behind and fiscal consolidation lacks a driving force, local banks might face serious debt risks and government debt will maintain a high level.
Ⅴ. A development model of relying on fiscal expansion to promote economic growth causes the Japanese government debt burden to stand at a high level, thus presenting grave challenges to sovereign credit.
Lacking the possibility of fiscal consolidation and dilemma concerning its monetary policy will both add to Japan’s sovereign credit risks. Given the knowledge that rapid population aging and a low fertility rate lead to labor shortages, the fact that manufacturing lacks technological innovation and that the country’s Internet economy lags behind, Japan’s growth momentum is significantly constrained. The development model of relying on fiscal expansion to boost growth brings Japan’s finances under constant pressure, and it is expected that 2018 will witness Japan’s general government debt burden to stand as high as 240.0%. Against the backdrop of the government’s ongoing fiscal expansion, factors amongst the Fed’s rate rises, balance sheet reduction, as well as ECB’s reducing its bond purchases will all leave Japan’s central bank to face a dilemma: whether to maintain the lure of the national debt market by keeping pace with the monetary policies of the EU and the U.S. or to stabilize government financing costs to sustain debt rolling by sticking to the quantitative easing program. Given the fact that the Japanese government relies heavily on debt monetization for repayment sources, it is expected that in 2018, Japan’s central bank will maintain its sovereign credit bubble by means of QE, but as central banks worldwide begin currency normalization one after another, it will cause Japanese sovereign credit to face grave challenges.