China: Risk Assessment
Country Rating1
Rating: A3
Business Climate Rating1
Rating: B
Risk Assessment2
Slight growth slowdown in 2011
China came through the crisis in remarkable fashion thanks to the effectiveness of the economic policies implemented: strong expansion of credit (up 33%), stability of the Yuan, and broad stimulus plan.
Nonetheless, in a context of rising inflation (5.5% in May 2011) and soaring credit, the authorities undertook to tighten economic policies: withdrawal of the fiscal stimulus, increases in interest rates and banks' reserve requirement ratio, re-introduction of quotas on the amount of loans that banks can grant. Measures were moreover implemented to limit speculation in the wake of sharp price increases in the high-end property market, particularly in China's major cities. And the People's Bank of China re-introduced a degree of flexibility in the yuan exchange rate regime with the currency consequently appreciating 5.3% from June 2010 to June 2011.
Despite these measures, economic growth remained strong in the first and second quarters, up respectively 9.7% and 9.5%. For the full year, however, the growth will be down slightly due to the continued tightening of economic policy. Public-sector investment, especially by local governments is expected to decelerate. Private corporate investment will, however, remain dynamic, bolstered by the solid performance of private consumption spread by the improvement in the job market and the wage increases obtained after the strikes in 2010.
Persistent weaknesses in companies, banks, and local governments
Companies have been contending this year with several shocks: withdrawal of subsidies and fiscal support measures, inflation and rising input prices, tighter monetary policy and a slowdown in bank credit (up 18% in April), appreciation of the yuan and substantial wage pressure. Although these changes will allow rebalancing growth towards higher consumption levels in the medium term, they nonetheless entail exposure to risks in the short term. Weaker private companies, particularly those of smaller size, will bear watching. These measures - needed to increase the proportion of GDP represented by Chinese wages - will especially affect low value-added sectors (textiles, shoes, toys) and sectors suffering from overcapacities (automotives, construction, steel).
The indebtedness of local governments, meanwhile, has increased substantially in the wake of the stimulus plan. Unable to assume debt in their own right, sub-sovereign entities have resorted to borrowing via local financing platforms (LFPs) with opaque operations. Banks have granted massive loans to LFPs despite the platforms' limited capitalization. Any risk of a chain reaction of defaults in 2011 is likely to be avoided thanks to intervention by the central government with substantial funds at its disposal and limited public debt. This would not exclude, however, individual cases of default by local governments: To avert any risk of moral hazard the government may be tempted to make a few isolated examples.
The rapid development of off-balance sheet loans and informal credit will bear watching in 2011. Small unofficial banks proliferated in 2010 and have been granting loans to companies without any controls. The main risk associated with these alternative sources of financing are the usurious rates they charge. And intercompany loans also constitute a major risk since a corporate bankruptcy may spread through this channel with suppliers and customers failing in succession.
Deficiencies in the business environment
In the political arena, the degree of inequality between rural communities and cities remains substantial. And despite recent progress on regulations, major governance shortcomings persist.
Strengths
- External accounts buoyed by industrial competitiveness and diversification
- Gradual move upmarket
- Infrastructure development spurred by the economic stimulus program
- Very high corporate savings rate that funds most investment
- China’s growing influence on the international scene
- Limited external indebtedness
- Sovereign risk under control with public sector debt largely domestic and denominated in renminbi
Weaknesses
- Increasing social tensions associated with the growth of inequality
- Industrial and commercial overcapacity
- Weakness of Chinese banks considering the dynamism of credit and the uncertainties over the amount of non-performing loans
- Environmental problems