China: Risk Assessment
Country Risk Rating
Business Climate Rating
- Sovereign risk contained as public debt remains mainly domestic and denominated in local currency
- Reduced risk of (private) external over-indebtedness thanks to the high level of foreign exchange reserves
- Gradual climbing in global value chains as part of China 2025
- Dynamic services sector, led by e-commerce trends
- Good level of infrastructure
- Increasing presence in emerging and developing countries through the BRI
- High corporate indebtedness set to impact growth potential
- Dependency on imports of key technology components
- Current account surplus expected to narrow and eventually turn into a deficit
- Misallocation of capital to the SOE sector could erode long-term potential growth
- Ambiguous government strategy on arbitrating between reform and growth
- Aging population, resulting in high public expenditure and higher labor costs
- Environmental issues
- Increasing tensions with India
- Risks that the real estate bubble bursts
Growth set to recover amid persisting downside pressures
China’s GDP is expected to rebound in 2021, but the recovery should remain uneven due to a weak outlook in domestic demand, despite an uptick in retail sales and investment. China is continuing to rebalance its economy towards a consumption-oriented economy, in line with the “dual circulation” target in its 14th five-year Plan. High corporate indebtedness (151% of GDP in 2019) and demographics remain concerns to the outlook in the longer-term. Cyclical factors will also continue to weigh on the outlook. Trade tensions between the U.S. and China are unlikely to ease under Biden’s administration, who is aligned with Trump on a tougher stance towards China, and existing tariffs should continue to exert downside pressure on Chinese growth, shaving off 0.7% from the GDP. While the Phase One trade deal signed in January 2020 had cooled tensions, China is unlikely to meet the import target, which would become a threat to the deal. As of September 2020, China had only imported half (USD 65.9 billion) of the total products required (USD 124.9 billion) from the U.S. That said, exports were resilient in 2020 amid the pandemic, driven by strong demand for medical supplies, and benefited from a reduction in the other countries’ manufacturing capacities. This led the Purchase Managers Indexes (PMI) to rebound from their pandemic-induced negative level into the expansion territory and should extend into 2021, albeit at a slower pace, as trade partners would barely be emerging from the second wave of lockdown measures. The manufacturing sector, which accounts for 40% of GDP, is set to have positive spillovers on domestic demand as unemployment is gradually declining towards pre-COVID-19 levels, reaching 5.4% as of September 2020. Therefore, household demand (65% of GDP) is likely to recover gradually in 2021, albeit slowly. The stimulus package (4.5% of GDP) unveiled in May 2020, aimed at boosting investment, showed only little support for Chinese consumers. As such, the pandemic and the government’s response slowed down the shift into a consumption-driven economy. Inflation is expected to drop slightly despite an uptick in demand post-pandemic. Pork prices have been easing since September 2020 as African Swine Fever cases are on a downward trend. Private investment should recover in 2021, as business sentiment improves amid higher profits and earnings, after dropping by -29.5% year-on-year in the first half of 2020.
High debt levels exacerbated by the pandemic
The current account surplus is likely to narrow in 2021. Private consumption, which should gradually recover, would spur imports to expand at a faster pace than exports. The currency has been under pressure from trade tensions and the pandemic but has remained broadly stable, as policymakers tightened capital controls and probably intervened in forex markets to prevent a steep depreciation. Despite the pandemic-induced shock, China appeared to be spared from capital outflows due to the capital controls. China continues to receive a large amount of Foreign Direct Investment (FDI), but a rapidly aging population and a dwindling trade surplus may impair its ability to generate savings that are significant enough to finance adequately the systemic build-up in debt in the long-term.
Debt levels, exacerbated by the pandemic, will remain extremely high (335% of GDP), with the bulk of it being owed by non-financial corporations. These corporations, predominantly state-owned, are struggling with high levels of debt and overcapacity. That said, state-owned enterprises (SOE) are mostly owned by provinces, which are inclined to keep them alive in order to avoid popular discontent. Moreover, corporate debt is difficult to assess due to shadow banking. That said, the shadow banking industry might continue to shrink in 2021, as regulators are looking to introduce more restrictions on the sector. For instance, China’s Supreme Court cut the ceiling of the legal informal lending rate in August 2020, which is a move aimed at supporting the development of the private lending sector.
Rebalancing towards domestic-oriented policies
On the domestic front, Beijing unveiled the 14th five-year Plan with no particular GDP growth target, although it is seeking to increase GDP per capita (USD 10,276 in 2019) to a moderate high-income economy (USD 12,536 according to the World Bank’s threshold) by 2035. The new five-year plan will also focus on a dual circulation model, rebalancing the economy from a predominantly export-led strategy over the last decades to a domestic-driven economic activity that relies on domestic production, distribution, and consumption. As such, this would help to reduce the dependence on foreign markets in times of external shocks (e.g. U.S.-China trade war and COVID-19). On the external front, despite Biden’s election, tensions between the U.S. and China are unlikely to ease much. Biden is expected to take up a tough stance against China, although possibly less confrontational than Trump’s, as he would seek to rely more on U.S. allies to confront China, especially regarding human rights violations.