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 high level of foreign exchange reserves and to the maintenance of a current account surplus
- Gradual move upmarket as part of China’s 2025 strategy to boost high-value-added output
- Services and infrastructure developments
- Credit risks remain a cause of concern; high corporate indebtedness set 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 likely moderate in 2018 due to more restrictive policies aimed at curbing financial vulnerabilities and asset bubble risks. In particular, the authorities are likely to ramp up efforts to reduce the weaknesses associated with corporate indebtedness. The People’s Bank of China (PBOC) maintains a “prudent” stance. PBOC tightened considerably in the first half of 2018. Tightening will continue only if this does not aggravate growth headwinds in the remainder of the year. The effects of a cooling property sector are expected to impact the real economy in 2018, especially as sluggishness spills over into second- and third-tier cities (according to the unofficial hierarchical classification of Chinese 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. The authorities are therefore expected to 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, shipbuilding, etc.) will put pressure on profits. This will act as a drag on already-slowing levels of private investment.
Current Account Surplus to Deteriorate
After contracting by 7% in 2016, exports in US dollars increased by approximately 8% in 2017. Exports have benefitted from robust demand in developed markets as well as higher commodity prices, but this has started to reverse. The appreciation of the Chinese yuan in 2017 (which reduced capital outflows) has also eroded export competitiveness, despite the yuan losing value since April 2018. Moreover, United States tariffs on up to USD 200 billion worth of Chinese imports will likely add to pressures. For these reasons, export growth is expected to slow to 5% in the second half of 2018. Although the current account returned to a surplus in the second quarter of 2018 and is expected to remain in surplus throughout the year, this surplus will likely narrow due to declining exports, as will the foreign investment surplus, despite capital controls remaining firmly in place.
Overall indebtedness in the Chinese economy remains extremely high (more than 260% of GDP). Most of the debt is owned by corporates, a large proportion of which are state-owned enterprises. Many of these are “zombie” enterprises: companies that are struggling with high levels of debt and overcapacity, but which continue to generate employment and output. In addition, corporate debt is difficult to assess due to the expansion of shadow banking: Moody’s estimates that shadow banking assets peaked at 87% of GDP in 2016, before falling to 73% at the end of June 2018. The government has been trying to curb this type of lending, leading to overall higher levels of loans on banks’ balance sheets. Finally, public debt may be higher than reported once the surge in local government financing through local government financing vehicles (LGVFs) is taken into account.
Strong Domestic Mandate Clashes with External Pressures
During the 19th National Congress of the Communist Party of China (CPC) that took place in October 2017, 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. President Xi Jinping did not announce a successor, and it is unlikely that his selection will come from this list: not only will most members be close to retirement age by the time the president steps down in five years, not everyone on the list belongs to the same faction as President Xi Jinping. Potential heirs will most likely come from the extended 25-member Politburo, where the president has supporters abound. On the foreign policy front, fears of a full-fledged trade war between the United States and China have now fully materialized. This is expected to have an impact equivalent to at least 0.5% of GDP, requiring an appropriate policy response. It remains unclear how this is compatible with the policy agenda for 2018: reducing corporate debt and curbing housing price speculation.