China: Risk Assessment

Country Rating1

Rating: A3

Business Climate Rating1

Rating: B

Risk Assessment2

Slowdown in growth contained in 2012 thanks to targeted stimulus

The slowdown in activity continued in H1 2012. Foreign sales, particularly to the eurozone, which captures 15% of total exports, shrunk (-11% in April 2012 YoY). Moreover, domestic demand is stagnating because of the tightening of economic policies focusing mainly on controlling investment and reducing the supply of credit (reintroduction of quotas on loans that banks can grant each year). The contraction in real estate transactions and the price drop in some first tier cities are also exerting downward pressure on the economy, the property sector representing 10% of GDP.

These property sector difficulties could affect the construction sector, particularly the metal and cement industries. In this context, targeted budget stimulus measures have been announced: construction of 36 million social housing units, support for SMEs in Wenzhou, scrapping bonus in the automotive sector, subsidies for purchasing household electrical appliances and for first-time home buyers; announcement of investment plans by several local governments representing at least 4 points of GDP between now and 2012. Moreover, given the difficulties in the export sectors, the appreciation of the yuan has slowed and should reach 3% in 2012 compared to 5% in 2011. On the other hand, an opening of the credit floodgates in the same way as observed in 2009 (credit then increased by +33%) has not, at this stage, been announced because of the risk of misallocation of resources, deterioration in the quality of bank assets and emergence of new bubbles. Despite the cut in bank reserve requirement ratio and interest rate, credit growth should remain under control (around +16%). However, if the crisis in the eurozone worsens, the authorities could choose to provide greater support to the economy.

 

Persistent weaknesses in SMEs, banks and local authorities

Chinese SMEs bear watching because they are contending with several shocks: substantial wage pressures (+20% in 2011 and +13% expected in 2012) and problems of access to finance. Bank credits being mainly allocated to state enterprises, SMEs are increasingly resorting to the informal system which charges usurious rates up to four times higher than those charged in the official banking sector. In a context of slowing demand from abroad, these SMEs - which account for 68% of exports, 60% of national wealth and 66% of patent licences - could soon find themselves in difficulty. A string of defaults is the main risk. In fact, since April 2012, company margins have contracted by 2%. Moreover, in spite of the encouraging results of stress tests conducted by the Chinese authorities on the 17 biggest commercial banks, the banking sector could be affected by the growing difficulties of the property sector. Though households post low debt ratio, this is, however, not the case with real estate developers who are facing financial pressure because of the growing illiquidity of the market and are sometimes forced to sell with big discounts. Additionally, the banks could suffer from the growing difficulties of local authorities. Not being permitted to get into debt on their own account, sub-sovereign governments have borrowed via local financing platforms (LFPs) with opaque modes of operation. The banks have lent massively to the LFPs while these are weakly capitalised. According to official estimates local government debt amounts to 27% of GDP. In 2012, the risk of a string of default should be avoided thanks to intervention by the state, which has a low level of public debt and has defined the conditions for the refinancing of this debt. The banks are being encouraged to extend the maturity of their loans and local governments have now been authorized to issue bonds. This, however, does not exclude occasional defaults by local authorities or second tier banks since, according to official estimates, 23% of loans granted to local authorities could become non-performing. The state, wishing to avoid the risk of moral hazard, could be tempted to make a few isolated examples.

 

Business environment shortcomings creditor position

In political terms, social tensions are likely to remain high, notably as a result of the frequent confiscation of agricultural land for the benefit of property developers. The mobilization of the villagers of Wukan, which resulted in the organization of municipal elections in March 2012, was a significant example of such social movements. Moreover, there are still substantial inequalities between rural and urban areas. Finally, major shortcomings in governance persist particularly in terms of access to corporate balance sheets. Indeed, the recent tightening of conditions for obtaining financial information on companies is a central concern, since it could significantly affect credit sales.

Strengths

  •  External accounts benefitting from competitiveness and industrial diversification
  •  Risk of foreign over-indebtedness limited thanks to the high level of foreign exchange reserves and to the current account surplus
  •  Sovereign risk contained: public debt mostly domestic and denominated in local currency
  •  Gradual move up-market
  •  Infrastructure development spurred by the stimulus package
  •  Very high corporate savings rate that funds most investments

Weaknesses

  • Growing social tensions linked to mounting inequalities
  •  Aging of the population and gradual drying up of the pool of abundant cheap labour
  •  Overcapacity in industry and trade
  •  Weakness of Chinese banks due to credit dynamism and uncertainty as to the level of non-performing loans
  •  Environmental problems

1Country and Business Climate Ratings courtesy of Coface (12/2013)
2Risk Assessment and methodology courtesy of Coface (12/2013).

Glossary