China: Risk Assessment
Business Climate Rating1
Slight slowdown in growth in 2014
The Chinese economy slowed slightly in 2013 and this deceleration continues in 2014. The authorities seem to have decided to introduce the reforms necessary for rebalancing growth in favour of consumption and a more efficient economy, giving a bigger role to the market. This rebalancing is on the way in early 2014: disposable income growth is catching up with GDP growth, credit is increasingly going to small companies, and the tertiary sector is growing more rapidly than industry. However, these reforms will only have a positive impact on growth sustainability in the medium term and could at first adversely affect some sectors. The sectors most affected will be those for which there is sizeable overcapacity and where State-owned enterprises are dominant, like steel, cement, aluminium, shipbuilding, glass manufacture, and photovoltaic. In order to come closer to the official GDP growth target (7.5% for 2014), the authorities took from April to June a series of actions, like starting infrastructure projects earlier than planned, or cutting the required reserve ratio for banks which have allowed large loans to SMEs and rural borrowers. However, without a larger stimulus, the target will be hard to reach.
Indeed, the property market begins to cool down: real estate investment, although the main growth driver in 2013, is now declining. Moreover, the recent downward trend in the growth of real estate prices could affect negatively both construction investment and household consumption. The latter is expected however to keep growing and wage increases continue. Besides, Chinese exports are expected, despite bad results in early 2014, to gain from the slight recovery in the Eurozone and the strength of the American economy. However, both the expected appreciation of the yuan - following the authorities’ decision to continue internationalisation of the currency - and the wage rises will adversely affect Chinese export competitiveness, despite the government-led depreciation of the beginning of the year. Furthermore, credit growth is slowing. Finally, the development of the Shanghai Free Trade Zone should support FDI entries.
Uncertainties over local authority and private sector debt
Given the expansion of “shadow banking” (estimated at 30% of total financing) it is difficult to assess precisely the level of private sector debt. Nevertheless, private sector debt is currently estimated at 200% of GDP, while in 2008, it was only 129% of GDP. At the same time, although the level of public debt is sustainable, local authority debt is substantial and lacks transparency. The national audit of the end of 2013 reported this debt to have reached Rmb17.9 Mds, i.e. about a third of China’s GDP. Moreover, bank loans represent no more than 58% of new finance granted during the first three quarters of 2013. Hence, although the level of non-performing loans in the banking system remains stable at 1% of total loans, this does not take into account all source of financing.
In March 2014, China experienced its first ever default with the photovoltaic firm Chaori. However panic risks have been contained since the firm’s problems were well-known and a bail-out from the government was consequently not expected. The introduction of a real risk of bankruptcy is a positive improvement which will reduce the moral hazard induced by the recurrent government interventions. In contrast, in January 2014, one of the largest investment trusts, China Credit Trust, had benefited from a last minute bail-out.
Another sign of financial tensions was reflected in the rumours in March 2014 concerning the bankruptcy of a small rural bank, Jiangsu Sheyang, that triggered the start of a bank run. However, the run has remained localized and contagion has been avoided thanks to the authorities’ early intervention.
Major reforms are planned but there are still shortcomings in the business environment
Politically, the transition from the previous administration was made with an emphasis on continuity. The Xi Jinping – Li Kiqiang tandem is facing both social tensions (which remain acute because of growing inequalities between rural and urban area) and ethnic tensions (deadly attacks in the mostly-Uighur Xinjiang region). Nevertheless, at the November 2013 Plenum, the leadership announced a number of emblematic reforms. The one-child policy will be relaxed, re-education-through-labour camps will be abolished and inequalities between rural and urban workers will be reduced. Finally major governance shortcomings persist, especially with regard to access to companies’ balance sheets and legal protection for creditors.
- External accounts benefiting from competitiveness and industrial diversification
- Limited risk of external indebtedness thanks to high level of foreign exchange reserves and a current account surplus
- Sovereign risk contained: public debt is mainly domestic and denominated in local currency
- Gradual move up-market
- Infrastructure development boosted by the stimulus plan
- Social tensions linked to rising inequality
- Share of consumption in GDP remains weak: rebalancing the Chinese growth model remains a medium term challenge
- Aging population and pool of abundant cheap labour gradually drying up
- Overcapacities curtain sectors
- Chinese banks weak, considering the credit dynamism, uncertainties over the level of non-performing loans and shadow banking
- Environmental problems