Singapore, May 24, 2017 -- Moody's Investors Service has today downgraded China's long-term
local currency and foreign currency issuer ratings to A1 from Aa3 and
changed the outlook to stable from negative.
The downgrade reflects Moody's expectation that China's financial
strength will erode somewhat over the coming years, with economy-wide
debt continuing to rise as potential growth slows. While ongoing
progress on reforms is likely to transform the economy and financial system
over time, it is not likely to prevent a further material rise in
economy-wide debt, and the consequent increase in contingent
liabilities for the government.
The stable outlook reflects our assessment that, at the A1 rating
level, risks are balanced. The erosion in China's credit
profile will be gradual and, we expect, eventually contained
as reforms deepen. The strengths of its credit profile will allow
the sovereign to remain resilient to negative shocks, with GDP growth
likely to stay strong compared to other sovereigns, still considerable
scope for policy to adapt to support the economy, and a largely
closed capital account.
China's local currency and foreign currency senior unsecured debt
ratings are downgraded to A1 from Aa3. The senior unsecured foreign
currency shelf rating is also downgraded to (P)A1 from (P)Aa3.
China's local currency bond and deposit ceilings remain at Aa3.
The foreign currency bond ceiling remains at Aa3. The foreign currency
deposit ceiling is lowered to A1 from Aa3. China's short-term
foreign currency bond and bank deposit ceilings remain Prime-1
(P-1).
RATINGS RATIONALE
RATIONALE FOR THE RATING DOWNGRADE TO A1
Moody's expects that economy-wide leverage will increase
further over the coming years. The planned reform program is likely
to slow, but not prevent, the rise in leverage. The
importance the authorities attach to maintaining robust growth will result
in sustained policy stimulus, given the growing structural impediments
to achieving current growth targets. Such stimulus will contribute
to rising debt across the economy as a whole.
RISING DEBT WILL ERODE CHINA'S CREDIT METRICS, WITH ROBUST
GROWTH INCREASINGLY RELIANT ON POLICY STIMULUS
While China's GDP will remain very large, and growth will
remain high compared to other sovereigns, potential growth is likely
to fall in the coming years. The importance the Chinese authorities
attach to growth suggests that the corresponding fall in official growth
targets is likely to be more gradual, rendering the economy increasingly
reliant on policy stimulus. At least over the near term,
with monetary policy limited by the risk of fuelling renewed capital outflows,
the burden of supporting growth will fall largely on fiscal policy,
with spending by government and government-related entities --
including policy banks and state-owned enterprises (SOEs) --
rising.
GDP growth has decelerated in recent years from a peak of 10.6%
in 2010 to 6.7% in 2016. This slowdown largely reflects
a structural adjustment that we expect to continue. Looking ahead,
we expect China's growth potential to decline to close to 5%
over the next five years, for three reasons. First,
capital stock formation will slow as investment accounts for a diminishing
share of total expenditure. Second, the fall in the working
age population that started in 2014 will accelerate. Third,
we do not expect a reversal in the productivity slowdown that has taken
place in the last few years, despite additional investment and higher
skills.
Official GDP growth targets have also adjusted downwards gradually and
the authorities' emphasis is progressively shifting towards the
quality rather than the quantity of growth. However, the
adjustment in official targets is unlikely to be as fast as the slowdown
in potential growth as robust economic growth is essential to fulfilment
of the current Five Year Plan and appears to be considered by the authorities
as important for the maintenance of economic and social stability.
As a consequence, notwithstanding the moderate general government
budget deficit in 2016 of around 3% of GDP, we expect the
government's direct debt burden to rise gradually towards 40%
of GDP by 2018 and closer to 45% by the end of the decade,
in line with the 2016 debt burden for the median of A-rated sovereigns
(40.7%) and higher than the median of Aa-rated sovereigns
(36.7%).
We also expect indirect and contingent liabilities to increase.
We estimate that in 2016 the outstanding amount of policy bank loans and
of bonds issued by Local Government Financing Vehicles (LGFVs) increased
by a combined 6.2% of 2015 GDP, after 5.5%
the previous year. In addition to investment by LGFVs, investment
by other SOEs increased markedly. Similar increases in financing
and spending by the broader public sector are likely to continue in the
next few years in order to maintain GDP growth around the official targets.
More broadly, we forecast that economy-wide debt of the government,
households and non-financial corporates will continue to rise,
from 256% of GDP at the end of last year according to the Institute
of International Finance. This is consistent with the gradual approach
to deleveraging being taken by the Chinese authorities and will happen
because economic activity is largely financed by debt in the absence of
a sizeable equity market and sufficiently large surpluses in the corporate
and government sectors. While such debt levels are not uncommon
in highly-rated countries, they tend to be seen in countries
which have much higher per capita incomes, deeper financial markets
and stronger institutions than China's, features which enhance
debt-servicing capacity and reduce the risk of contagion in the
event of a negative shock.
Taken together, we expect direct government, indirect and
economy-wide debt to continue to rise, signalling an erosion
of China's credit profile which is best reflected now in an A1 rating.
REFORMS WILL NOT FULLY OFFSET THE RISE IN ECONOMIC AND FINANCIAL RISK
The authorities are part of the way through a reform program intended
to sustain and enhance the quality of growth over the longer term,
as well as to reduce the risks to the economy and the financial system
posed by high corporate and, in particular, SOE debt.
One related objective is to contain, and ultimately reduce,
SOE leverage.
The authorities' commitment to reform is clear. It is quite
likely that their efforts will, over time, improve the allocation
of capital in the economy. Over the nearer term, the authorities
have taken steps to contain the rise in SOE debt and to discourage some
SOEs from further domestic and external investment, particularly
in over capacity sectors.
However, we do not think that the reform effort will have sufficient
impact, sufficiently quickly, to contain the erosion of credit
strength associated with the combination of rising economy-wide
leverage and slower growth. In particular, in our view,
the key measures introduced to date will have a limited impact on productivity
and the efficiency with which capital is allocated over the foreseeable
future.
For example, one key set of reforms is the program of debt-equity
swaps which aims to lower leverage in parts of the SOE sector, transferring
the associated risks to the banking sector. At present, we
estimate that the value of swaps announced is a very small fraction --
around 1% -- of SOE liabilities. Moreover, there
is very little transparency about the terms of these transactions or their
likely impact on SOEs' and banks' creditworthiness.
Other measures intended to improve investment allocation include negative
lists on investment in excess capacity sectors and the introduction of
mixed ownership. The former will likely reduce the major losses
on investments of the past. However, excess capacity sectors
only account for a small proportion of total investment. Only limited
improvement in the allocation of capital would result from such measures.
Meanwhile, mixed ownership is at a very preliminary stage,
having been introduced in only a few dozen SOEs, and on too small
a scale for now to have any impact on productivity in the economy as a
whole.
Looking beyond the corporate sector, the financial sector remains
under-developed, notwithstanding reforms introduced to improve
the provision of credit; pricing of risk remains incomplete,
with the cost of debt still partly determined by assumptions of government
support to public sector or other entities perceived to be strategic.
And with increased scrutiny of capital outflows, the capital account
remains largely closed. While that insulates the economy and financial
system from global volatility, it also constrains the development
of domestic capital markets by limiting the flow of inward and outbound
capital.
Overall, we believe that the authorities' reform efforts are
likely, over time, to achieve some measure of economic rebalancing
and improvement in the allocation of capital. But we think that
progress will be too slow to arrest the rise in economy-wide leverage.
RATIONALE FOR THE STABLE OUTLOOK
The stable outlook reflects our assessment that, at the A1 rating
level, risks are balanced.
China's credit profile incorporates a number of important strengths,
most notably its very large and still fast-growing economy.
The government's control of parts of the economy and financial system
and cross-border financial flows provides policy and financial
scope to maintain economic, financial and social stability in the
near term. In particular, China's largely closed capital
account significantly reduces the risks that financial instability could
arise as it attempts to reduce leverage when the economy has been reliant
on new debt.
Large household savings at around 40% of incomes, according
to the IMF and OECD, reinvested within China, provide ample
financing for new debt. As long as liquidity can be quickly funnelled
to where it is needed, financial stability risks will remain low.
In addition, China's sizeable foreign exchange reserves of
around $3 trillion give the central bank abundant financial power
to preserve the stability of the currency and thereby avoid financially
destabilising scenarios of capital flight.
WHAT COULD CHANGE THE RATING UP/DOWN
The stable outlook denotes broadly balanced upside and downside risks.
Evidence that structural reforms are effectively stemming the rise in
leverage without an increase in risks in the banking and shadow banking
sectors could be positive for China's credit profile and rating.
Conversely, negative rating pressures could stem from leverage continuing
to rise faster than we currently expect and continuing to involve significant
misallocation of capital that weighs on growth in the medium term.
In particular, in this scenario, the risk of financial tensions
and contagion from specific credit events could rise, potentially
to levels no longer consistent with an A1 rating.
GDP per capita (PPP basis, US$): 15,399 (2016
Actual) (also known as Per Capita Income)
Real GDP growth (% change): 6.7% (2016 Actual)
(also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 2.1%
(2016 Actual)
Gen. Gov. Financial Balance/GDP: -2.9%
(2016 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: 1.8% (2016 Actual) (also
known as External Balance)
External debt/GDP: 12.7% (2016 Actual)
Level of economic development: Very High level of economic resilience
Default history: No default events (on bonds or loans) have been
recorded since 1983.
On 21 May 2017, 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
fiscal or financial strength, including its debt profile,
have not materially changed.
The principal methodology used in these ratings was Sovereign Bond Ratings
published in December 2016. 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.
Marie Diron
Associate Managing Director
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
Atsi Sheth
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653
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
