Even before the financial crisis made a mockery of credit ratings, there was always a bit of a mystery over what exactly made for an AAA entity, The Economist Schumpeter blog reported. Broadly, it was seen as a statement of corporate solidity–the hallmark of an entity with an enduring franchise. Writ small, it suggested an ability to honour financial commitments forever. Confidence that this sort of description fit America has recently been shaken. Is it possible that China’s mighty rail industry could be the repository of such trust?
The standard is not, of course, absolute. The very fact that ratings can be reduced undermines the basic premise of reliability. Perhaps the best that could be said is that a collapse would not be precipitous. Even before this was called into question by the financial crisis and the wave of busted mortgage securities, however, that theory was punctured by the 1987 bankruptcy of AAA-rated Texaco. The company had appeared to be a picture of financial health until a huge legal setback over a takeover bid pushed it into bankruptcy proceedings.
At the very least, though, ratings suggest something about strength, hence the wails by the Obama administration over the decision by Standard & Poor’s to downgrade America. Ahead of S&P’s move, a similar decision to cut America's rating had been taken by Dagong, a state-backed rating agency in China. Its prescient call on America prompted interest in what the agency might consider truly safe.
An answer emerged on August 10th when it bestowed a AAA rating on the rapidly mushrooming debt of China’s railway ministry, a regulator and operator of the country’s vast, growing rail network. It was a curious choice. The ministry runs the high-speed rail line that suffered a crash on July 23rd that killed dozens, if not hundreds, of passengers (the body count is still unclear). If China had a robust tort system, the claims against the ministry would be stacked to the sky. That it does not perhaps explains a bit of why the ministry's credit rating can be so high.
But litigation is not the ministry’s only problem. The crash led to a slowdown of high-speed rail services, which will mean less revenue from fares, as well as a service that is less competitive with air travel. A consequence of the ministry’s frenetic effort to link one end of China to another with fast trains has been a massive increase in construction-related debt. In 2007 the ministry’s liabilities-to-assets ratio was 47%. At the end of the first quarter of 2011, it was 58%. Its losses for the quarter were 3.8 billion yuan ($600m).
Rumbling in the background are widespread concerns that whatever led to the July crash is merely a symptom of wider problems in the construction and operation of China’s rail network. There have been sporadic reports of problems, as well as occasional reports of problems being covered up. Even if all went well, it was never clear whether the high-speed services would generate enough income to cover cover the staggering costs of construction and operations. Read more.
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