China: Risk Assessment
Country Risk Rating
|A4||A somewhat shaky political and economic outlook and a relatively volatile business environment can affect corporate payment behavior. Corporate default probability is still acceptable on average.|
Business Climate Rating
|B||The business environment is mediocre. The availability and the reliability of corporate financial information vary widely. Debt collection can sometimes be difficult. The institutional framework has a few troublesome weaknesses. Intercompany transactions run appreciable risks in the unstable, largely inefficient environments rated B.|
Further slowdown in Chinese economy in 2016
The Chinese economy is expected to continue slowing in 2016. The authorities are implementing reforms needed to rebalance growth in favor of consumption and services. This is however hitting the profits of companies with large overcapacities and with high levels of debt. Despite the ongoing monetary easing since November 2014 and the expansionary budget measures, investment is likely to remain limited in 2016. As companies are heavily indebted, the monetary relaxation is proving ineffective and the volatility of the financial markets could undermine confidence levels of among investors and consumers. In this context of a slower rise in disposable incomes, household consumption is likely to slacken somewhat. Despite the very rapid expansion in online sales, retail sales are losing momentum.
Although there was a rise in property prices in the main cities in 2015, the construction related sectors are likely to remain flat because of high inventory levels. A collapse in the housing market is however not very likely, as the authorities have the capacity to intervene in the event of a severe shock. The growth of the services sector, in particular financial, is also continuing.
Exports are however expected to continue suffering the weakness of global demand and the country’s loss of competitiveness.
The credit risk of companies is increasing
Although the level of public debt is sustainable, that of local municipalities is high (at around a third of GDP) and remains opaque. In order to reduce the financial costs for local government and kick-start infrastructure developments, the government has implemented a swap program that allows the conversion of short term credits into long term bonds.
In addition, corporates are highly indebted and the expansion of shadow banking makes it very difficult to evaluate. In 2014, the debt of companies and financial institutions accounted for almost 200% of GDP. On top of this and despite the monetary policy easing, SMEs frequently have to rely on shadow banking at exorbitant rates, given their difficulty in securing financing.
In this context there has been a gradual decline in the quality of banking assets which are also under-estimated because of the scale of shadow banking. The official ratio of non-performing loans reached 1.59% at the end of the third quarter 2015, its highest level since 2009. The credit risk has increase significantly, highlighted by the growing number of defaults on the Chinese bond market. Thus, in April 2015, China has experienced its first SOE default with the photovoltaic company Baoding Tianwei. These events have not, so far, led to any signs of panic. The introduction of real bankruptcy risk is inevitable and will reduce moral hazard generated by government interventions. In the context of the economic slowdown, the solvency of more fragile borrowers will still need to be monitored in 2016
The Chinese stock markets recorded a significant correction during summer 2015. Following a rise of more than 110% between November 2014 and June 2015, shares lost more than 43% in less than 3 months before firming up slightly. Admittedly this market correction can be seen as a healthy development after such a sharp rally disconnected from corporates’ fundamentals, volatility and equity price deflation have generated additional risks. The heavy use of margin finance (investors borrow money to buy shares) has increased the credit risk and could worsen the downwards spiral.
Business climate continues to suffer shortcomings
Whilst reaffirming the supremacy of the Chinese Communist Party (CCP), the Central Committee session of the CCP in October 2014 concluded with decisions relating to an improvement in the state of law. In addition, the 5th plenum of the Communist Party, which was held in October 2015, ended the one child policy and reaffirmed the desire on the part of the authorities to develop the social protection system. However, the national security reform project has caused concern among some NGOs and foreign investors. Despite a seamless transition from the previous administration, President Xi Jinping wields unprecedented authority over the CCP, particularly following the anti-corruption campaign which targeted the highest-ranking party dignitaries. However, the Xi Jinping – Li Keqiang administration is facing both social and ethnic unrest. The country has seen an increasing level of worker activism which caused the authorities to publish a guide on the development of “harmonious work relations”. Finally, major shortcomings in term of governance persist, particularly concerning access to company balance-sheets and legal protection for creditors.