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China, Japan Facing Downgrade of Debt Rating: Fitch

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China may see its credit rating lowered within the next two years, Fitch Ratings said Thursday, thanks to the debt carried by its banks as the result of efforts to overcome the 2008 financial crisis. Japan, too, was in the crosshairs, thanks to its own debt woes and the political standoff preventing any substantive action to resolve them.

Reuters reported that the ratings agency said China’s downgrade could come within the next two years. Andrew Colquhoun, head of Asia-Pacific sovereign ratings at Fitch, was quoted in the report saying, “We expect a material deterioration in bank asset quality. If the problems in the banking system pan out as we expect or are even worse over the next 12 to 24 months, then that would incline us to take the rating downwards.”

China’s long-term local currency debt was downgraded by Fitch to negative from stable in April over worries that the country may have endangered its own financial stability with a spate of loans used to sustain economic growth during the crisis. The agency has the only negative outlook on long-term local currency debt, and has been the most vocal in its warnings about the lending surge.

Nonperforming loans, said Colquhoun, made up about 2% of the total, but if proper classification had been made regarding lending to local government financing vehicles, it would be more like 6-7%. “That by itself is sufficient to exhaust the banks’ internal absorption capacity,” he said in the report. “So any further deterioration in asset quality beyond that … would lead to a requirement for sovereign support, which then affects the sovereign credit profile.”

He added that because the Chinese stimulus was done through its banking system instead of in a more obvious form, as in Western countries, “in a nutshell we don’t know how much it cost. We haven’t seen the full cost come through yet.”

Japan’s political situation is the trigger for its own difficulties, he said. “We think the ratings on current trends are more likely than not to go down. To shore ratings up at their current level we need to see a credible fiscal consolidation plan. Our confidence that we will see it is not high because of the track record of the politics.”