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 move up global value-chains as part of China 2025
- Dynamic services sector, led by e-commerce trends
- Good level of infrastructure
- High corporate indebtedness to impact growth potential
- Dependency on imports of key technology components
- Current account surplus expected to narrow and eventually turn into deficit
- Misallocation of capital to SOE sector to erode long-term potential growth
- Government strategy is ambiguous on arbitrating between reform and growth
- Ageing population, resulting in high public expenditure and higher labour costs
- Environmental issues
Growth to dip below 6.0%
China’s GDP is expected to fall below the watershed level of 6.0% in 2020. This is the result of both structural and cyclical factors. China continues its gradual rebalancing process towards a consumption-oriented economy, with a focus on quality over quantity of growth. Corporate indebtedness and demographics pose threats to the long-term outlook of the economy, requiring structural reforms that take time. Cyclical factors are adding to the pressures. Trade tensions between the United States and China have somewhat eased with the partial trade deal announced in December 2019, but existing tariffs will continue to exert downside pressure on Chinese growth with a 0.7% impact on GDP. Exports contracted by -0.8% in the first three quarters of 2019. This led to PMIs falling into contractionary territory for most of 2019, a trend that is set to extend into 2020. The indirect impact via sentiment channels is also noteworthy. A sluggish manufacturing sector, which accounts for 40% of GDP, will have negative spillover effects on domestic demand and services through income and employment channels. As a result, household consumption, which accounts for a much larger portion of GDP, about 65%, is set to slow further from 8.0% on average in 2019. An uptick in inflation, on the back of soaring pork prices following an outbreak of the African Swine Fever, may further dampen domestic demand. Private investment has also remained sluggish, slowing to 5.4% year-on-year in the first three quarters of 2019, as business sentiment drags amid lower earnings and profits. Measures to stabilize the housing market will continue to remain in place, removing any upside on prices.
Despite these headwinds, the authorities have been moderate in their approach to stimulus. An additional package of fiscal measures worth 4 trillion yuan was announced in March 2019. Beijing did not expand these despite weaker growth in Q3. In addition, the People’s Bank of China (PBOC) has only implemented targeted monetary stimulus measures, including Reserve Requirement Ratio (RRR) cuts and liquidity injections via open market operations (OMOs). These serve the purpose of limiting the risk of an interbank liquidity squeeze and supporting Small and Medium Enterprises (SMEs). At a systemic level, outstanding credit growth has remained flat, expanding by 10.6% YOY in the first nine months of 2019, compared to 11.2% in 2018.
Current account deficit amid credit concerns
Imports contracted faster than exports in 2019. However, we envision that the economy will register a very modest current account deficit in 2020, driven by measures to boost consumption and weak external demand. Policymakers are likely to intervene in forex markets to avoid overshooting depreciation expectations. A weaker yuan may help to boost China’s terms of trade, but it may also reignite capital outflows; even if capital controls remain firmly in place. A small current account deficit poses no threat in the medium term. However, it could aggravate existing credit risks depending on how it is financed. 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 adequately finance the systemic build up in debt in the long run.
Debt levels remain extremely elevated (260% of GDP), with most of it being owed by corporations. A large proportion of these companies are struggling with high levels of debt and overcapacity, and are predominantly state-owned. Moreover, corporate debt is difficult to assess due to the expansion of shadow banking. Moody’s estimates that shadow banking assets fell to 67% at the end of March 2019. The figure could be higher when taking into account other types of financial intermediation by banks, including Wealth Management Products (WMPs). Finally, public debt may be higher than reported if you include the surge in local government financing through bond issuance and special purpose vehicles.
Less politics, more pedaling on reforms
Political factors have all posed challenges for the Chinese economy in 2019. Beijing’s response has comprised of hardening the official rhetoric, both domestically and in terms of its foreign policy. For example, the Third Plenum of the Communist Party of China (CCP), which usually emphasizes economic reforms, focused on intra-CCP discipline instead. We expect that tensions with the U.S. continue to play a role in the long term, even in case both sides finally reach an agreement to deescalate trade tariffs. Beyond trade, both sides may intensify targeted attacks on individual companies, in line with what we have seen so far with Huawei, ZTE and FedEx.