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Original
article at
China's Unfair
Advantage
How
China’s Artificial Credit Rating Hurts U.S. Manufacturers
–
Improper Sovereign Benchmark Gives Chinese Companies Cheap
Access to Foreign Capital
TUCSON,
Ariz., July 25 -- It’s not just low wages that gives
China a major competitive advantage over U.S. manufacturing
companies. U.S. manufacturers are also hurt by the assignment
of an improper and artificial investment-grade sovereign credit
rating to the government of China, which enables Chinese companies
to raise foreign capital for expansion of operations more
cheaply than would be the case if the Chinese government’s
credit rating reflected the existence of China’s defaulted
sovereign debt. According to a 2002 report issued by the U.S.-China
Commission, Chinese corporations raised an estimated $20 billion
over the past decade from international bond offerings denominated
in U.S. dollars, including approximately $9.7 billion from
U.S. markets. In an aggressive bid to set the stage for a
fresh round of debt issuance by Chinese corporations and secure
additional ratings business, Standard & Poor’s Rating
Service last week raised China’s sovereign credit rating
from “BBB+” to “A-.”
Sovereign
Advisers, a private financial research and investment analysis
firm, recently filed a complaint with the U.S. Securities
and Exchange Commission Division of Market Regulation and
the Committee of European Securities Regulators, pertaining
to the inappropriate and misleading sovereign credit ratings
assigned to the People's Republic of China (http://www.globalsecuritieswatch.org/SEC.pdf).
The complaint, predicated upon the existence of defaulted
full faith and credit sovereign obligations of the Chinese
government, was filed on behalf of U.S. bondholders and has
begun to draw the attention of the U.S. Congress. The Chairman
of the Congressional Joint Economic Committee has rightfully
demanded that the SEC open an investigation into this very
serious matter, which also has broad implications with respect
to both CNOOC's financing of its unsolicited takeover bid
for Unocal as well as to U.S. manufacturing companies facing
competition from Chinese companies (http://www.globalsecuritieswatch.org/chairman_saxton_demand_for_investigation.pdf).
In commenting
on the complaint and the prospect of an SEC investigation
into the matter, Mr. Christopher Mahoney, Executive Vice President
of Moody's Investors Service, was recently quoted as stating
that a country's past default "does not preclude ...
a high rating today." Mr. Mahoney's statement presupposes
that the past default was cured through discharge or settlement
of the debt. Such is not the case in the instance described
in the complaint, wherein the defaulted debt was settled in
the U.K. but neither settled nor discharged in the U.S., where
it has been left outstanding and continues to be evaded by
the government of China. According to Mr. John Petty, president
of the Foreign Bondholders Protective Council, “Mr. Mahoney
selectively disregards this discrimination against U.S. citizens.
This kind of behavior by Moody’s and S&P- ignoring
an issuer’s defaulted obligations when assigning a credit
rating-hurts Americans who have been discriminated against
in foreign government bond defaults.”
The "nationally
recognized statistical rating organization" status enjoyed
by Fitch Ratings, Moody's and Standard & Poor's entails
a very high degree of responsibility to the investing public.
Unfortunately, such diligence is not evident in their respective
China sovereign credit ratings. Statements such as those offered
by Mr. Mahoney, which dismiss an obvious fact, do nothing
to enhance the overall credibility of the rating agencies.
This aspect is described in detail in a letter prepared by
Sovereign Advisers and delivered to Mr. David M. Walker, Comptroller
General of the United States (http://www.globalsecuritieswatch.org/GAO_LETTER.pdf).
China’s
“Willingness to Pay” Ignored in Setting Benchmark
Rating
China
possesses a reported $691 billion in foreign exchange reserves,
yet continues to shamefully evade payment of its defaulted
sovereign debt in violation of international law. Such behavior
is blatantly inconsistent with the "willingness to pay"
metric implied in an investment-grade rating. As Richard Brookhiser
stated in his recent article on Alexander Hamilton, entitled
"Alexander the Great" (Wall Street Journal, June
30th), "Mr. Hamilton knew that if the United States started
picking and choosing among its creditors, its credit would
go back into the outhouse." This same standard need not
apply to the government of the People's Republic of China
so long as the three major rating agencies continue to aid
and abet China's evasion of payment on its defaulted sovereign
debt through artificially inflated credit ratings.
China’s
Defaulted Sovereign Debt: Selective Default vs. Investment
Grade
All ratings
agencies agree that a debtor is in default when it either
misses a payment beyond a grace period or seeks to renegotiate
the loan – anything, says S&P’s Marie Cavanaugh,
that is not “timely service of debt according to the
terms of issue.” In fact, S&P’s own “Selective
Default” classification states “An obligor rated
“SD” (Selective Default) has failed to pay one or
more of its financial obligations (rated or unrated) when
it came due. An “SD” rating is assigned when Standard
& Poor’s believes that the obligor has selectively
defaulted on a specific issue or class of obligations but
it will continue to meet its payment obligations on other
issues or classes of obligations in a timely manner.”
Unfortunately, S&P selectively ignores that fact that
a prime example of selective default is the Chinese government’s
refusal to honor the series of full faith and credit sovereign
obligations issued as the Chinese Government Five Per Cent
Reorganization Gold Loan, scheduled to mature in 1960 and
which remains in default under international law as a payment
obligation of the People’s Republic of China as the successor
government. Failure to assign a “Selective Default”
rating to the Chinese government represents a violation of
S&P’s own internal policy. Commenting on last week’s
upgrade, Sovereign Advisers president Kevin O’Brien stated
“an investment-grade sovereign rating is not warranted
for China, given the existence of defaulted sovereign debt
of the Chinese government. Last week’s upgrade by S&P
is a transparent attempt to protect its China ratings franchise
in the face of anticipated competition resulting from new
legislation (H.R. 2990) introduced by Representative Mark
Fitzpatrick (R-PA) which will open up the credit rating industry
to new entrants.”
China’s
Artificial Credit Rating Hurts U.S. Manufacturers
The assignment
of the proper rating classification for sovereign debt of
the Chinese government (i.e., "Selective Default")
would effectively function to prevent bond-financed takeovers
of U.S. corporations by Chinese state-owned enterprises, since
a "default" rating of the Chinese sovereign benchmark
(which generally acts as the international credit rating ceiling
for all Chinese corporations) would no longer permit Chinese
corporations to access international debt financing at an
artificially-subsidized cost until such time as the sovereign
default is cured. Such a ratings adjustment to reflect the
existence of defaulted obligations of the Chinese government
would help to level the playing field for American businesses
in competition with Chinese manufacturers, which enjoy cheap
access to capital as a result of the Chinese government's
investment-grade sovereign rating.
Congress
Takes Action on China’s Defaulted Sovereign Debt
The U.S.
Congress is finally taking action to remedy this inequity.
In addition to Rep. Fitzpatrick’s legislation, the chairmen
of both the Joint Economic Committee and the House Appropriations
Committee, along with influential members of several other
key Congressional committees have written to the SEC calling
for the agency to investigate the conduct of the credit rating
agencies in setting the sovereign credit rating for China
(http://www.globalsecuritieswatch.org/congress.html). Congress
is also poised to take further action pending introduction
of anticipated legislation intended to halt the issuance of
new Chinese government securities in the U.S. capital markets
until the Chinese government cures its defaulted sovereign
debt.
As holders
of full faith and credit sovereign obligations of the government
of China, U.S. bondholders continue to suffer from both selective
default and a discriminatory settlement (i.e., the 1987 settlement
with British bondholders which excluded U.S. citizens). There
is no excuse for the major international credit rating agencies
to continue to pretend otherwise. China's credit ratings should
reflect evasion of payment on the country's defaulted sovereign
debt. It is unfortunate that the prospect of losing a significant
share of the Asian corporate ratings business would sway S&P,
Moody’s and Fitch Ratings to assign an investment-grade
rating to a government in default. It is also interesting
to note that Goldman Sachs and JP Morgan, which have pledged
$3 billion in bridge financing for CNOOC’s takeover bid,
would find it difficult to sell bonds to investors if China’s
credit rating reflected the existence of defaulted sovereign
debt. In a similar vein, perhaps the Chinese government should
cure its defaulted debt before allowing its state-owned enterprises
to launch takeover attempts on U.S. companies.
References
Reference
to Mr. Christopher Mahoney's quote:
http://www.globalsecuritieswatch.org/press.html
Reference to the Joint Economic Committee:
http://www.globalsecuritieswatch.org/chairman_saxton_demand_for_investigation.pdf
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