Singapore, August 29, 2022 -- Moody's Investors Service ("Moody's") has today affirmed China's A1 long-term local- and foreign-currency issuer and senior unsecured ratings and the (P)A1 foreign-currency senior unsecured shelf rating. The outlook remains stable.
The A1 rating affirmation is driven by Moody's assessment that the core strengths of China's credit profile, particularly its high economic strength and robust fiscal strength, are likely to remain in the medium term. At the same time, China's institutional and governance strength will be tested, including the quality of executive institutions, to manage a complex set of policy issues including enhancing productivity, reducing leverage, creating an environment in which the property sector can foster sustainable growth and wealth accumulation, promoting environmental sustainability and maintaining social stability. While in all these areas the medium-term policy objectives are supportive to China's debt sustainability, transition risks are material.
The stable outlook reflects the possibility of renewed episodes of economic and financial stress during the above-mentioned transition, at least at a regional level, which could put material downward pressure on the sovereign rating if policy effectiveness and the quality of executive institutions are not sufficient to stem the pressure on growth and the banking sector. These downside risks are balanced by significant economic and fiscal buffers that will support the sovereign rating through temporary and localized stress and a track-record of effective policy response and ongoing gradual reform.
China's local- and foreign-currency country ceilings are unchanged at Aaa and Aa1 respectively. The local currency ceiling, four notches above the rating, reflects limited external risks, broadly predictable institutions; offset by a large government footprint and influence in the economy and financial system which could lead to government decisions that are credit negative for non-government issuers. The foreign currency ceiling, one notch below the local currency ceiling, reflects the net impact of strong policy effectiveness, low external debt but also a history of capital account controls which point to some, albeit limited, transfer and convertibility risks in a low probability scenario of the sovereign facing very significant financial stress.
RATIONALE FOR THE RATING AFFIRMATION
CHINA'S ECONOMIC AND FISCAL STRENGTHS WILL CONTINUE TO SUPPORT THE CREDIT PROFILE, EVEN AS CONTINGENT LIABILITY RISKS REMAIN.
China's large and competitive economy has remained relatively resilient to the significant challenges posed by Covid-19 and the authorities' dynamic zero-Covid policy and the marked slowdown in the property sector. In particular, according to Moody's, the overall economic scarring incurred as a result of the pandemic will be moderate. Over the longer-term, China's growth potential will continue to slow due to population ageing. However, China's high economic strength will remain, supported by rising income levels and strong global competitiveness.
In the near term, Moody's revised its growth forecast to 3.5% and 4.8% for 2022 and 2023 respectively to take into account the impact of potential renewed local lockdowns and the constraints on consumption posed by the country's dynamic zero-COVID policy, partially mitigated by an unfolding macroeconomic policy response. Over the medium term, a shrinking population and labour force and slower growth in the property sector than experienced in the past decades will significantly weigh on China's growth potential.
However, Moody's expects gradual reforms which continue to enhance innovation and technological development, educational quality, rebalancing of growth towards high value manufacturing and services sectors and the productivity of state-owned enterprises (SOEs), which will support productivity and GDP growth and allow living standards to continue to rise.
Moody's assesses that China's fiscal strength also remains relatively robust, taking into account the fiscal and debt impact of the Covid-19 shock. Moody's estimates that general government debt will amount to 49% of GDP at the end of 2022, compared to 39% in 2019, a moderate increase compared to other sovereigns globally. However, the deterioration in China's broader public debt position has been more significant when considering increases in Local Government Financing Vehicles (LGFVs) and SOE debt. For instance, considering the general government and LGFVs together, Moody's estimates that the debt burden will stand at 96% at the end of this year, compared with 74% pre-COVID. These increases in public sector debt reflect the fundamental, long-term issue of mismatches between regional and local government (RLGs) revenue base and their economic and social spending responsibilities. This mismatch has been exacerbated by the combination of the impact on revenue growth of lockdowns and the decline in property sector activity. Though a significant portion of the SOE sector is solvent, the debt at financially weak SOEs represents a contingent liability for China's government, a characteristic that significantly shapes China's sovereign credit profile. If these contingent liabilities crystallised on a significant scale through a sharing of the costs across the public sector, the sovereign's fiscal strength would be materially undermined.
At the same time, China's debt affordability is likely to remain strong. Moody's research also indicates that policies directed at reducing debt among the most indebted SOEs have met with some success, moderating contingent liabilities risks. Notwithstanding the step-up in overall public sector debt, Moody's assesses that de-leveraging remains an important element of China's policy goals, as reflected in the authorities' relative restraint in easing fiscal policy during the pandemic and focus on constraining LGFV leverage, for example by requiring infrastructure investments are carried out by RLGs to be economic and/or have social returns.
TRANSITION STRESSES WILL CHALLENGE CHINA'S EXECUTIVE CAPACITIES
China faces a wide range of policy challenges to enhance productivity and offset the growth impact of population ageing, reduce leverage in the public sector without jeopardizing financial stability, creating an environment in which the property sector can foster sustainable growth and wealth accumulation at manageable growth and social costs, promoting environmental sustainability across its vast and diverse geography and economic structures, and maintaining social stability.
Looking at the experience of the past two years, Moody's assesses that the transition cost of key policy imperatives, including reducing the economic role of the property sector that periodically faces imbalances between supply and demand and contributes to wealth inequality; and fostering 'Common Prosperity', has some negative short-term growth implications.
While the overall policy goals stated above are credit positive in the long term, their implementation has highlighted some weaknesses in the capacity of China's executive institutions, notably in recognizing the pathways and potential wide-ranging impacts of policy changes. In turn, this contributes to a degree of policy uncertainty, which potentially reduces the effectiveness of policy reforms.
Uncertainty around regulatory change, for example around regulation of internet platforms and education, and the recent stresses in the property sector, risks undermining consumers' willingness to spend and investors' readiness to invest. More generally, policy execution that raises uncertainty for consumers delays the shift towards a more consumer and services sector driven economy, while uncertainty affecting corporates and investors undermines innovation and productivity.
Overall, at this stage, Moody's assesses that the quality of institutions and governance strength in China is moderate, combining a track-record of effective policy in some areas and the signs of weaknesses in execution summarized above. The wide-ranging and ambitious policy agenda, reflecting economic and social needs, may test the quality of institutions and governance further than currently assumed.
POLITICAL RISKS WILL BE CONTAINED DESPITE INCREASING GEO-POLITICAL TENSIONS
Latent geo-political tensions have been consistent with Moody's view that the relationship with the United States (Aaa stable) in particular will continue to be fractious due to economic issues such as intellectual property rights and industrial policy, and an evolving role for both nations in the Asia-Pacific region. However, beyond periodic flare-ups, it appears unlikely that such tensions will escalate to a point that would materially undermine China's sovereign rating.
RATIONALE FOR STABLE OUTLOOK
The stable outlook on China's rating reflects balanced risks at the A1 rating level. Episodes of financial stress, including those flowing from stresses in the property sector, further implementation of the Common Prosperity policy or aims to deleverage SOEs, are likely to continue to test the capacity of the central and regional governments to differentiate between liquidity and solvency pressure, prevent contagion and continue to foster innovation. However, large fiscal and foreign exchange reserves, and the government's control of parts of the economy and financial system lend effectiveness to measures aimed at stemming financial, and ultimately social, stability risks.
ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS
Environmental considerations continue to pose a significant challenge to China's authorities and over the long term may raise fiscal costs, constrain economic growth in some regions and consequently the credit outlook. Key areas include significant remediation costs related to the long-term impact of industrial development on air quality, soil degradation and water quality. Moreover, climate change manifests in extreme weather conditions, which risks undermining investment if they become increasingly frequent.
All of these facets of environmental damage have the potential to raise health care costs over the longer term at a time when the ageing population is putting additional demands on China's health-related spending.
At this stage however, Moody's expects that the government's prioritization of environmental risk preservation, and a track record of effectiveness for instance at reducing air pollution, mitigate these risks.
Social considerations are material to the credit, given the authorities' focus on maintaining social stability through economic growth and policies driven by the Common Prosperity framework. Policy has focused on supporting employment at the aggregate level and assisting adjustment where unemployment has been a consequence of policy or structural change in the economy. Recently China has faced the challenge of managing the social pressures of its reforms directed at reducing the role of the property sector in the economy. In the medium term, China also faces challenges relating to its ageing population and shrinking workforce. These will increasingly weigh on potential growth and threaten large increases in social security spending. Social risks are mitigated by the government's capacity to deliver support that partially offsets the negative effects of an economic and demographic transition.
Governance considerations are material to China's rating. The quality of China's executive institutions is being challenged by a wide range of issues including the structural changes affecting the property sector, and the coordination and execution of policy between the central and regional and local governments. At the same time, China has a track record of relatively effective macroeconomic policy.
GDP per capita (PPP basis, US$): 19,260 (2021) (also known as Per Capita Income)
Real GDP growth (% change): 8.1% (2021) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 1.4% (2021)
Gen. Gov. Financial Balance/GDP: -3.1% (also known as Fiscal Balance)
Current Account Balance/GDP: 1.8% (2021) (also known as External Balance)
External debt/GDP: 15.5% (2021)
Economic resiliency: a2
Default history: No default events (on bonds or loans) have been recorded since 1983.
On 24 August 2022, a rating committee was called to discuss the rating of the China, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutions and governance strength, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has not materially changed.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Evidence that China's authorities are successfully meeting the complex challenges across key policy issues including productivity, leverage and the framework for policy coordination and execution between different levels of government could lead to an upgrade. Effectively managing the range of economic, environmental and social pressures resulting from developments on these issues would be a credit positive signal for such an outcome.
Negative pressure could stem from evidence that the challenges of sustaining economic growth, reducing leverage growth, and improving the effective coordination and execution of policy, including at the regional and local government level were not being met could lead to a downgrade. Rising financial, social and economic instability would be a credit negative signal of such an outcome.
The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://ratings.moodys.com/api/rmc-documents/63168. Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions.
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VP - Senior Credit Officer
Sovereign Risk Group
Moody's Investors Service Singapore Pte. Ltd.
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MD - Sovereign Risk
Sovereign Risk Group
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Moody's Investors Service Singapore Pte. Ltd.
71 Robinson Road #05-01/02
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077