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Announcement:

Moody's: Conflicts between China's main policy objectives raise risk that momentum on reform will slow

 The document has been translated in other languages

08 Mar 2016

Singapore, March 08, 2016 -- Moody's Investors Service says that China's (Aa3, negative) policy makers appear to have set themselves three main policy objectives: maintaining reasonably high rates of GDP growth, reforming and rebalancing the economy, and ensuring financial and economic — and thereby social — stability. The Government Work Report delivered to the National People's Congress on 5 March made explicit reference to each of these policy objectives.

"However, against the backdrop of China's slower economic growth, capital outflows and rising corporate stress, it will be increasingly difficult for these policy objectives to be achieved in unison," says Michael Taylor, a Moody's Managing Director and Chief Credit Officer for Asia Pacific.

"With the government having now given a strong commitment to a growth target of between 6.5%-7.0%, it seems unavoidable that one of the other policy objectives will assume lesser priority. The most likely near-term casualty is reform momentum."

"We believe that achieving even the lower end of the growth target for 2016 is likely to require further substantial monetary and fiscal stimulus, as evidenced by the 50-basis-point cut to the required reserve ratio in February and the government's announcement of a 3% fiscal deficit for this year", adds Taylor. "This level of policy support is likely to frustrate the government's ability to achieve at least one of its other objectives."

Moody's analysis is contained in its just-released report titled "China Credit: Conflicts Between Policy Objectives Raise Risk That Momentum on Reform Will Slow".

Moody's report points out that it will be difficult even to implement two of the three objectives at any one time.

If the authorities choose to prioritize reform while trying to maintain a growth target of in excess of 6.5%, the consequence will be to sacrifice some degree of financial stability, and accept a larger level of RMB depreciation, more widespread defaults, and perhaps even some failures in the banking system.

Alternatively, a combination of growth and stability is also achievable, at least for some time, but such a strategy will leave unaddressed the deep imbalances in China's economy, such as elevated system leverage and excess capacity. The risk is that the support necessary to achieve 6.5% growth instead postpones the restructuring of the SOE sector by creating artificially favorable demand and maintaining accommodative financing conditions for loss-making, as well as viable SOEs.

In addition, the implementation of the accommodative monetary policy needed to support growth would lead to further downward pressure on the RMB and would likely delay much-needed deleveraging.

The depreciation of the RMB can therefore only be avoided by stepping back from the commitment to a more open capital account, thereby substantially slowing the pace at which this and related reforms, such as more market-based credit allocation, would be enacted.

A third combination would be to try to combine reform with financial stability, but allow growth to decelerate below current targets. This combination would involve the authorities eschewing fiscal or monetary stimulus to revive investment in the pursuit of growth targets, using their still substantial fiscal and reserves buffers to smooth currency and financial market volatility, and proceeding with policy reforms.

Moody's points out that in view of the strength of the commitment to China's growth target of 6.5%-7.0%, and given the finite nature of foreign reserves, this third course seems the least likely of the three combinations.

Subscribers can access the report at http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_1018631

The report may also be found through this link to Moody's topic page titled China — Reform and Rebalancing: http://www.moodys.com/chinarebalancing. The topic page provides subscribers with a centralized source for Moody's research related to key credit issues in China, as the country's rebalancing story unfolds.

Recent Moody's publications relating to China Reform and Rebalancing include:

- Government of China -- Aa3 Negative: Update Following Change in Outlook to Negative from Stable

- Asset Managers - Global: China Market's Gradual Opening Is Credit Positive for Foreign Asset Managers

- Inside Renminbi Bonds - February 2016

- Chinese Banks: Chinese Banks' Strong Loan Growth Raises Overall Financial Leverage, a Credit Negative

- Sub-Sovereign: Chinese Regional and Local Government Debt and Finances Snapshot

- Chinese City Metro Companies: Links with Owner-Governments Underpin Credit Quality (Presentation)

- China's Power Market: Sluggish Electricity Demand, But Headroom Within Credit Profiles Provides Support

- Chinese Regional and Local Government Bond Program Continues, a Credit Positive

- Property - China: PBOC Cuts Down-Payment Requirement Further, a Credit Positive for Developers

- Inside China - February 2016

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

Rahul Ghosh
Vice President
Corporate Finance Group
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Michael Taylor
Managing Director
Credit Policy
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Releasing Office:
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Moody's: Conflicts between China's main policy objectives raise risk that momentum on reform will slow
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