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The China downgrade and the Yukon economy

The economic rise of China is of more than academic interest to Yukoners. These days, we hear often from early-stage mining and energy companies in the Yukon that North American investors are exceedingly skittish about financing risky projects.

The economic rise of China is of more than academic interest to Yukoners. These days, we hear often from early-stage mining and energy companies in the Yukon that North American investors are exceedingly skittish about financing risky projects. Big state-backed Chinese companies represent another, potentially huge, source of capital.

Without capital, of course, early-stage projects don’t advance to production. That is bad news for existing shareholders and the Yukon workers and suppliers who would support a producing mine. It is also bad for the Yukon and First Nation governments looking for royalties and income tax revenues from workers and companies.

Big Chinese companies already own major, even controlling, stakes in Yukon outfits. Wolverine, an operating mine, is owned by China’s Northwest Nonferrous International and Jinduicheng Molybdenum Group. CNOOC, China’s largest offshore oil and gas company, owns a controlling stake in Northern Cross, which is pushing natural gas opportunities in northern Yukon. And Yunnan Chihong Zinc and Germanium is a major shareholder in Selwyn, a potentially massive mine on the Yukon-N.W.T. border.

The Chinese Politburo gave direction several years ago that the largest state-owned Chinese companies should make a major push outward, especially in resource industries. The list of recent Chinese investments from Africa to South America to the Yukon is impressively large, despite considerable controversy in some countries (including Canada) about Chinese investment.

The big question is: what happens next? Do those huge outflows of Chinese capital continue? Or will there be a sudden change in direction, due perhaps to new political direction from China’s new Politburo or some kind of economic bad news in China itself?

In this context, how worried should we be by last week’s banner headlines that China was downgraded by Fitch, a credit ratings agency?

First of all, some context is in order on the downgrade. Fitch maintained its rating on China’s foreign debt. The country has $3.4 trillion - yes, trillion - in foreign reserves, after all. Fitch only downgraded China’s domestic debt. Even the rating on this was only marked down to A+, from AA-. Not exactly like shouting “Greece!” in a crowded room of investors.

According to Fitch, official Chinese statistics suggest bank loans to the private sector were 136 per cent of gross domestic product, “the third-highest of any Fitch-rated emerging market.” And including “shadow banking,” which includes loans by non-banks, it could be 198 per cent of GDP. This is almost double the 2008 figure, an astonishing rise that has provoked some China-watchers to utter the alarming words “Chinese credit bubble.”

Furthermore, Chinese local governments have also gone on a borrowing spree. Their tottering balance sheets are further undermined by unknown, but possibly huge, commitments to local-government-owned businesses.

All of this has led China bears to be increasingly pessimistic about China’s ability to sustain whopping growth rates into the future. China bulls, on the other hand, point to a range of other statistics to suggest Chinese debt issues are relatively minor in the cosmic scheme of things. Others are in the middle, watching China carefully but not yet ready to pull the fire alarm.

The Economist called the downgrade “symbolic,” since China’s overall debt levels remain reasonable and the Chinese government retains the ability - unlike Greece - to simply print money to pay its debts.

But the underlying trends behind the Fitch report are cause for concern. Rapid credit growth anywhere can lead to bubble-like behaviour, with excessive investment in the short term driving growth but painful adjustment following. China’s government is already trying to put the brakes on lending growth, but this is a tricky thing to do even in countries with well-developed financial systems and good statistics.

So what could this all mean for the Yukon? It’s hard to say for sure, but there are several “transmission mechanisms” that could lead to less Chinese investment in foreign resource projects in places like the Yukon.

The first is that a dip or even a slowdown in the Chinese economy will hit the bottom lines of big Chinese state-owned companies. With profits harder to find, and their own debt to repay, they will be less likely to splash out on risky investments in junior resource companies or projects.

The second transmission mechanism is via Chinese government policy. If credit problems cause economic slowdowns and unemployment at home, the Politburo is likely to direct big Chinese companies to invest at home rather than overseas. Readers of the The Party by Richard MacGregor will know that the Chinese government exercises remarkably strong control over the big state-owned companies, which are the ones that have been doing most of the resource investing overseas.

The third major transmitter is global commodity prices. Global metal prices would drop like a copper ingot if there were a major slowdown in China. And this would be bad news for northern mining projects. The impact of a Chinese slowdown on natural gas prices is harder to predict because gas behaves more as a regional than a global commodity. But it wouldn’t be positive, and a glut of gas in northeastern B.C. and northern Alberta won’t help anyone trying to drill in the Yukon.

Time will tell how these trends play out. Several Yukon mining companies are trying to raise capital this year, so the thing to look out for is announcements of more Chinese investment in the Yukon. Or not.

Correction: My review of the Guild’s Chicago: The Musical gave the incorrect impression that Jeremiah Kitchen was an alumni of the Wood Street Music Art Drama (MAD) program. Apologies. However, I stick by my assertion he is a very talented young performer. The MAD alumni in Chicago included Rebecca Whitcher, Harmony Hunter, Emma Dube and Eli Boivin plus Kieran Poile in the orchestra and Gareth Sloan on follow spot.

Keith Halliday is a Yukon economist and author of the MacBride Museum’s Aurore of the Yukon series of historical children’s adventure novels.