China's market volatility stresses the need for strong policy reforms: S&P

The Chinese government's recent measures to stem heavy losses in the stock market have set back its stated aim of increasing the role of markets in the economy, said Standard & Poor's Ratings Services today in a report titled, "China's Stock Market Volatility  Highlights The Need For Strong Policy Reforms."

"We believe the central government has shown a reduced regard for long-term implications when addressing immediate risks," said Standard & Poor's credit analyst Kim Eng Tan. "Such actions put policy credibility and effectiveness into question. Our institutional assessment on China is currently neutral to the sovereign rating, which is supported by a strong external and fiscal assessment."

In our opinion, unless China significantly strengthens its policymaking to match the increasing sophistication and openness of the financial system and economy, it may slow the progress of economic rebalancing and eventually weaken sovereign credit metrics over the next three to five years. Risks to stability of the financial sector form one trigger that could put downward pressure on our sovereign credit rating on China.

However, we believe the pressure on China's sovereign creditworthiness over the next two years (the outlook horizon for investment-grade sovereigns) remains contained.

"In our view, the central government's policy agenda will make China's economy more resilient to shocks; changes in GDP will be less severe. This assessment includes our assumption that China is able to curb credit growth and gradually shift its growth model away from investment toward private consumption," Mr. Tan said.

One important implication of these measures in China is that they present a moral hazard.

"The stock-market support measures could embolden investors' belief that the government will continue to limit their losses as they take on risks in the future. This again runs counter to the government's goal over the past few years to rein in moral hazard issues--for example, local and regional governments relying on bank loans to local government financing vehicles to implement infrastructure projects,"