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Rating Action:

Moody's affirms China's A1 ratings, maintains the stable outlook

 The document has been translated in other languages

04 Jul 2019

Singapore, July 04, 2019 -- Moody's Investors Service has today affirmed China's A1 long-term issuer and senior unsecured ratings and the (P)A1 foreign-currency senior unsecured shelf rating.

The outlook is maintained at stable.

The A1 rating is supported by Moody's assessment that, while economy-wide leverage will likely continue to rise and pockets of financial stress will periodically become apparent, the authorities have the financial and policy means to contain the rise in leverage, mobilise resources to support stressed public sector entities and maintain financial stability.

The stable outlook on China's rating reflects balanced risks at the A1 rating level. Episodes of financial stress for some local banks or state-owned enterprises (SOEs) are likely to continue to test the capacity of the central and regional governments to prevent contagion. 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 stability risks.

China's long-term foreign-currency deposit and bond ceilings remain at A1 and Aa3, respectively, while the local currency deposit and bond ceilings remain at Aa3. China's short-term foreign-currency bond and bank deposit rating ceilings remain at P-1.

RATINGS RATIONALE

RATIONALE FOR THE RATING AFFIRMATION

POLICY EMPHASIS TO CONTINUE TO SHIFT BETWEEN DELEVERAGING AND DEBT-FINANCED GROWTH

The direction of leverage and the debt-servicing capacity of entities taking on leverage remain a key driver of China's sovereign credit profile.

The government's commitment to reducing leverage remains clear, and deleveraging and derisking measures have demonstrated their effectiveness when economic conditions allow. However, over the medium term, Moody's continues to expect leverage in the economy as a whole to rise gradually. In particular, both public sector debt (central and local governments and SOEs, including local government financing vehicles (LGFVs)) and household debt are likely to increase. In turn, the economy's reliance on debt-financed expenditure points to a policy trade-off, at least in the short term, between deleveraging and maintaining robust growth.

The rapid shrinking of the shadow banking sector and deleveraging in parts of the SOE sector in 2017 and the first half of 2018, reduction in overcapacity in the steel and coal sectors, and some progress towards greater transparency of debt and contingent liabilities for regional and local governments (RLGs) support Moody's view that authorities remain committed to reducing leverage and addressing the main sources of financial risks.

At the same time, the policy emphasis has moved towards greater quality of growth, including environmental and social objectives, and a reduced emphasis on the level of growth.

However, over the past year, the policy trade-off between deleveraging and maintaining robust growth has become increasingly apparent. The policy decisions since mid-2018 support Moody's assessment of a policy preference for maintaining growth as the prime objective. To that end, and in the face of headwinds from trade tensions with the US and the negative economic impact of tighter credit availability, the government has announced an increasingly broad and economically significant range of stimulus measures.

Tensions with the US, which Moody's expects to continue and oscillate between more and less intense phases, further complicate the Chinese government's balancing of its growth and deleveraging objectives. Moody's expects GDP growth to slow slightly this year and next to 6.2% and 6.0%, respectively, partly as a result of higher tariffs on exports to the US and of the second-round negative impact that this has on investment and consumption, despite additional policy stimulus. The dispute with the US is also likely to slow the economy's long-term move towards more high-tech, high value-added and high productivity sectors.

If trade tensions escalate, Moody's assumption is that the Chinese authorities will respond to the more pronounced negative economic impact by providing policy support, as seen recently. The A1 rating is also based on Moody's expectation that in this scenario, policy support would be designed and calibrated to maintain growth not far below the current rates, without leading to a sharp increase in leverage by the government or SOEs.

Over the medium term, leverage is likely to rise gradually, while policy emphasis tends to shift between deleveraging and support to growth, and in the absence of significant progress and continuity of reforms that reduce the credit intensity of the economy through the economic cycles. In particular, the public sector is likely to continue playing a key role in supporting growth. Moody's expects government debt to rise towards 50% of GDP in 2025 from 37% in 2018, while public sector debt is likely to rise towards 160% of GDP in 2025 from 137% in 2018.

Contingent liability risks will remain for the government, in particular as RLGs continue to face a gap between their financing sources, including transfers from the central government and bond quotas, and the cost of investment in physical and social infrastructure. As has been the case in recent years, this gap will be filled by SOEs, including LGFVs. In Moody's view, contingent liability risks for the sovereign will persist when LGFVs or SOEs with weak debt-carrying capacity are relied on to support growth.

FINANCIAL STABILITY EXPECTED TO BE SUSTAINED THROUGH PERIODIC LOCAL FINANCIAL STRESS

The A1 rating also reflects Moody's assumption that, while it is likely to be tested periodically, the effectiveness of China's policy and its financial capacity to maintain economic and financial stability will remain.

With only limited progress achieved so far on SOE reform that would result in a material improvement in the allocation of capital, instances of local financial stress with increased risks of materialization of contingent liabilities are likely to continue to occur. A moderate but persistent share of SOEs is highly leveraged with poor prospects for investment returns. In this context, policies that prevent an increase in local financial stress and that effectively stem contagion when stress arises will be key to maintaining financial stability.

So far, periods of rapid tightening liquidity in the interbank market have been relatively short-lived, with evidence of effective support provided by the central bank directly and through the large state-owned banks. Similarly, idiosyncratic events of acute financial pressure have been addressed, with stabilizing financial support provided between local governments, financial institutions and SOEs. Creditors have incurred losses in some cases, but spillover effects to the wider economy and financial system have not been material.

Steps towards greater reliance by RLGs on bond issuance as a source of financing, and restrictions on RLGs' reliance on LGFVs and on LGFVs' capacity to raise debt will contribute to financial stability through greater transparency around potential financial pressures. Similarly, the derisking of the financial system, through the shrinking of the shadow banking sector to 66% of GDP in the first quarter of 2019 from 87% in 2016, contributes to greater transparency and reduces the risk of contagion from financially weak shadow banks to banks.

However, coordination between the different parts of the public sector to stem contagion is complex. Risks remain that either information about financial pressure is not available on a timely basis, or that connections between a financially stressed entity and the broader economy and financial system are underestimated.

Moreover, some of the policy measures aimed at derisking will have unintended consequences. For instance, the clampdown on shadow banking has led to a sharp tightening of short-term finance availability for private sector enterprises, particularly in the small and micro enterprise (SME) sector. It is as yet unclear whether the guidance provided to banks to lend to the SME sector will materially improve access to credit.

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook on China's rating reflects balanced risks at the A1 rating level.

Episodes of financial stress for some local banks or SOEs are likely to continue to test the capacity of the central and regional governments to prevent contagion.

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 stability risks. A move towards current account deficit over time will also be mitigated by ample reserves, which will allow time to explore a range of tools to slow the consequent gradual erosion of the reserves buffer.

WHAT COULD CHANGE THE RATING UP

Evidence that structural reforms will achieve their objective of limiting the decline in medium-term growth in the coming years, while also stemming the rise in public sector leverage and containing financial stability risks, could lead to an upgrade. Evidence of increasingly effective coordination within the public sector to achieve key policy objectives and address emerging financial stress would be a credit positive signal of such an outcome.

WHAT COULD CHANGE THE RATING DOWN

Conversely, negative pressure could stem from evidence that the medium-term growth rates that the government seeks to achieve will be achieved through further material increases in leverage, which would exacerbate economic distortions and raise financing stability risks. In this scenario, the risk of financial tensions and contagion may rise, especially if the flow of information about financial health at a local level and the transmission of decisions are slow.

GDP per capita (PPP basis, US$): $18,110 (2018 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 6.6% (2018 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 1.9% (2018 Actual)

Gen. Gov. Financial Balance/GDP: -2.6% (2018 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 0.4% (2018 Actual) (also known as External Balance)

External debt/GDP: 14.4% (2018 Actual)

Level of economic development: High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 1 July 2019, 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 institutional strength/framework have slightly increased. Other views raised included: The issuer's economic fundamentals, including its economic 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.

The principal methodology used in these ratings was Sovereign Bond Ratings published in November 2018. Please see the Rating Methodologies page on www.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.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Martin Petch
VP - Senior Credit Officer
Sovereign Risk Group
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Marie Diron
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 852 3758 1350
Client Service: 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
Client Service: 852 3551 3077

No Related Data.
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