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 strengthening of 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
- Reliance 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 for arbitrating between reform and growth
- Aging population, resulting in high public expenditure and higher labor costs
- Environmental issues
- Increasing complex and uncertain external environment
- Risks that the real estate bubble bursts
- Unclear political succession plans
China’s GDP growth is expected to moderate from its 2021 recovery and return to its pre-COVID trend in 2022. The focus is maintained on economic transition but also emphasizes macroeconomic stability. However, efforts to maintain the balance between multiple objectives will be tenuous. In recent years, the government has de-emphasized the importance of GDP targeting, opting not to set a numerical growth target for the 14th Five-Year Plan (2021-2025), and announced only a conservative GDP goal of at least 6%’ for 2021. The Chinese economy grew 8.1% in 2021, partially lifted by the low base effect in 2020. Total consumption, a combination of household (39% of GDP) and government spending (17% of GDP), contributed 6.4 percentage points (%pts), followed by net exports (2.4% of GDP) at 1.9 %pt, and investments (42% of GDP) at 1.5 %ps. However, sequential growth rates (seasonally adjusted) were muted in the first nine months of 2021 (0.2 to 1.2% QoQ) and notably weaker than the long-run average of 1.8% QoQ.
Indeed, domestic demand remains subdued. Retail sales rose by 3.9% YoY in November 2021, well short of their approximately 8% growth pre-pandemic, suggesting an impact from prolonged and ad hoc mobility restrictions. Yet, the surveyed urban jobless rate fell to a near three-year low of 4.9% in September 2021, down from the 2020 average of 5.6%. Meanwhile, fixed asset investments (FAI) rose by 5.2% in the January-November 2021 period, linked to softening growth in real estate development (about a quarter of FAI) at 6% and a near-flat increase in infrastructure investments (0.5%). However, fixed investment growth, particularly in infrastructure spending at local and regional levels, may accelerate in 2022 as the authorities indicated more excellent fiscal support, stressing the importance of maintaining a stable and healthy economic environment ahead of the 20th National Party Congress (NPC). On foreign trade, the possible boost to demand for Chinese exports (IT, phones, electronics, home furnishing, automotive, clothing) from potential renewed restrictions of production capacities and mobility abroad may be offset by chip and shipping shortages, as well as rising costs of raw materials and energy.
With the revived theme of ‘common prosperity,’ raising peoples’ income and improving access to housing and other social services will remain a top priority of the Chinese Communist Party (CCP). However, in the near term, the prolonged zero-COVID strategy will prevent a full recovery of household consumption, delaying the transition to a consumption-led economy. The authorities will also face formidable challenges to achieve their longer-term dual-carbon goals while avoiding shorter-term energy transition pains, such as power shortages experienced in the second half of 2021. The pandemic’s trajectory remains the main immediate risk to China’s economic outlook. Still, the slowdown in the property sector (29% of GDP) is also a significant risk, with important implications for real estate development, construction activity, and local government’s finances that rely significantly on land sales. While tighter measures will continue to be implemented, the government will seek to avoid a collapse in the housing market by tapping into various policy levers (e.g., normalizing property-related financing) to ensure the completion of projects and payments to contractors and suppliers, primarily by preventing default from significant developers. Further monetary easing expected in 2022 should also add some support.
Deleveraging on backburner
We expect the current account surplus in 2022 to be broadly similar to 2021’s level, supported by a substantial goods trade surplus. The services balance deficit should see little change as prolonged restrictions on outbound travel will continue to constrain tourism services outflows. The renminbi has appreciated through 2021, with the authorities concerned about the currency strength and imposing measures such as raising banks’ FX reserves twice in the year. China continues to receive a large amount of Foreign Direct Investment (FDI), with FDI growth in January-November 2021 at 15.9%.
Overall domestic non-financial sector debt will remain high (265% of GDP in Q3 2021), with 60% being owed by non-financial corporations. These corporations, many of which are state-owned (SOE), need help with high debt levels and overcapacity. While SOEs are owned mainly by provinces, defaults on their bonds have been on the rise due to Beijing’s increasing willingness to impose market discipline and to break away from the idea of an implicit state guarantee for SOE debt. However, deleveraging efforts are expected to slow or even come to a temporary halt in 2022 as the government prioritizes stability ahead of the autumn NPC.
Leadership succession in focus
The Chinese Communist Party (CCP) will hold its 20th National Congress in late 2022. This twice-a-decade event will provide clues as to the next generation of leadership, especially potential successors to Xi Jinping, who is widely expected to remain the top leader for an unprecedented third term. Strategic competition and tensions between the U.S. and China are long-term trends on the external front. The Phase One trade deal signed in January 2020 eased tensions, but China needs to catch up on import targets, which could threaten the agreement.