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 external over indebtedness thanks to the high level of foreign exchange reserves and to the maintenance of a current account surplus
- Gradual move upmarket as part of China 2025 strategy to boost high-value added output
- Services and infrastructure developments
- Credit risks remain a cause of concern. High corporate indebtedness to impact growth potential
- Overcapacity concerns in certain industrial sectors will continue to drag on profits
- Exposure of banks to rising corporate debt levels and deterioration in asset quality
- Government’s strategy is ambiguous on arbitrating between reform and growth
- Environmental issues
- Ageing population and gradual depletion of cheap labor pool
Gradual Deceleration in 2018
Chinese growth will continue to moderate in 2018. This moderation will be brought about by more restrictive policies aimed at curbing financial vulnerabilities and asset bubble risks. In particular, the authorities will ramp up efforts to reduce the vulnerabilities associated with corporate indebtedness. The People’s Bank of China (PBOC) has resumed monetary policy tightening. The authorities have also stepped in to curb housing price speculation in major cities. The effects of a cooling property sector have yet to materialize into a slowdown in the real economy. This is expected to take place in 2018, especially as sluggishness spills over into second- and third- tier cities. Consumption, which accounts for two-thirds of GDP, has remained on target, supported by relatively low inflation. Fiscal policy was very accommodative in 2017. 2018 will see authorities oscillate between policy accommodation and tightening in order to manage a gradual slowdown. Rising levels of corporate indebtedness coupled with overcapacity concerns in some sectors (cement, aluminum, chemicals, ship building, etc.) will put pressure on profits. This will act as a drag on already slowing levels of private investment.
Current Account Surplus
Exports in US dollars increased by approximately 8% in the first ten months of 2017 compared to the same period in 2016. Exports have benefited from robust demand from developed markets as well as higher commodity prices. The yuan appreciated, which has helped to reduce capital outflows, but its appreciation has not yet been strong enough to erode export competitiveness. However, it is unlikely that any more yuan appreciation will be tolerated in 2018. The current account is expected to shrink slightly but remain in surplus in 2018.
In the first quarter of 2017, the Chinese financial account was in surplus for the first time in three years, with an upturn in net non-FDI flows, as a result of stricter enforcement of capital controls. Even if this surplus is good news, it does not reflect a significant increase in capital inflows. Authorities will continue to tighten the screws to avoid outflows while simultaneously attempting to attract more foreign investment. For example, stock and bond connects between Hong Kong and the two onshore financial centers Shanghai and Shenzhen were inaugurated in 2017.
Overall indebtedness in the Chinese economy remains extremely elevated (more than 260% of GDP at the end of 2016, compared with 160% in 2008). Most of the debt is held by corporates, a large proportion of which are state-owned enterprises. Many of these are “zombie” enterprises, struggling with high levels of debt and overcapacity, but which generate employment and output. In addition, corporate debt is difficult to assess due to the expansion of shadow banking; while public debt may be higher than reported if you factor in the surge in local government financing through local government financing vehicles (LGVFs). Moody’s estimates that shadow banking assets grew by 21% in 2016, to reach 87% of GDP. The number of bond defaults increased in 2016 and 2017, and it is expected that the pace of defaults will continue as the authorities focus on removing implicit guarantees and reducing debt.
Uncertainties Dissipate on the Domestic and Foreign Political Fronts
During the 19th National Congress of the Communist Party of China (CPC), all members of the Politburo Standing Committee – excluding President Xi Jinping and the Premier Li Keqiang – retired. The new line-up includes Li Zhanshu, Wang Yang, Wang Huning, Zhao Leji and Han Zheng. The future policy direction is expected to be announced at the inauguration of the new Politburo in March, albeit some details will likely be leaked before then. Xi Jinping did not announce a successor and it is unlikely that this will come from this list for two reasons: first of all, most members will be close to retirement age by the time President Xi steps down in five years; and second, not everyone on this list is a “Princeling” –a faction within the Communist Party comprised of descendants of prominent and influential communist officials, of which President Xi is a member. Most likely, a number of members will be groomed to become potential heirs from the extended 25-member Politburo, where Xi Jingping supporters abound.
On the foreign policy front, fears of a full-fledged trade war between the US and China have dissipated, but the new American administration will continue to impose anti-dumping charges on Chinese goods on a case-by-case basis. The crux of the question in the coming months will be to observe how the relations between China and the US evolve over tensions in the Korean peninsula. Some progress on this regards seems apparent following from U.S. President Donald Trump’s visit to China in November 2017. Diplomatic tensions surrounding The Hague’s decision to rule in favor of Philippines in a high-level case over China’s activities in the South China Sea have also eased compared to a year ago.