Fitch Affirms China at 'A+'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed China's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'A+' with a Stable Outlook. The issue ratings on China's senior unsecured local-currency bonds are also affirmed at 'A+'. The Country Ceiling is affirmed at 'A+' and the Short-Term Foreign-Currency IDR at 'F1'.
KEY RATING DRIVERS
China's ratings balance a strong sovereign balance sheet and sustained high GDP growth against high sovereign contingent liabilities and a range of structural weaknesses and risks.
China's economic growth over the past 20 years has been domestically and globally transformative, but it has been accompanied by a build-up of imbalances and vulnerabilities that pose risks to the country's basic economic and financial stability. Fitch thinks China has the administrative and financial resources to address these issues in a gradual and orderly way. However, the risk remains of a sharper, more disruptive and credit-negative adjustment. Even in its fairly benign base case, the agency expects the adjustment will lead to slower growth with more economic and financial volatility, which have already become apparent.
China's levels of income and development remain low compared with peers, despite nearly 40 years of rapid growth since market-oriented reforms began in 1978. Average income is around USD8,000 at market rates or USD13,100 at purchasing-power parity, well below 'A' medians at USD18,200 and USD25,500 respectively, and well below 'AA' range comparators. Standards of governance lag 'A' norms according to standard international surveys. These fundamental credit weaknesses weigh on the ratings.
China's sovereign external balance sheet is a central rating strength. Official foreign reserves were USD3,525.5bn at end-October 2015 - down 11% from the peak in August 2014, but still by far the world's largest. Reserves are worth about 17 months of current external payments, greatly in excess of the 'A' median of 3.5 months. Official reserves dwarf government foreign debt, which Fitch estimates at USD36bn for end-2015. China's ratio of sovereign net foreign assets to GDP, estimated at 37% end-2015, is the second highest in the 'A' range after Taiwan.
Fitch expects the International Monetary Fund Executive Board to include the Chinese renminbi in the basket of currencies comprising the IMF's Special Drawing Rights (SDR) at its meeting on 30 November 2015. The change in the SDR basket would then happen in October 2016. Fitch does not expect this to lead to a material shift in demand for renminbi assets globally in the short term. Over time, the emergence of the renminbi as a global reserve currency could support the credit profile.
The broader external finances remain a credit strength, although capital flows and the exchange rate have become more volatile. China as a whole is a net external creditor with debt-like assets at about 40% of GDP. The country runs a structural current-account surplus - Fitch expects the surplus to rise to 2.9% in 2015 from 2% in 2014. However, capital flows have become more volatile since mid-2014. A move to a more flexible setting of the exchange rate in August 2015 that led to a modest depreciation of the currency took investors by surprise and seems to have sparked heavy outflows for a period, although these appear to have eased off again in the latest data for October. Overall, Fitch does not view capital flows as systemically threatening given the depth of the foreign reserves buffer and China's enduring current account surplus.
The agency estimates general government debt at 53% of GDP at end-2015, up from 49% at end-2014 and close to the 'A' range median of 51%. Central government debt is the second-lowest in the 'A' range at 14.6% of GDP at end-2015. Fiscal solvency and financing flexibility are further supported by deposits worth about 5.6% of GDP. Fitch adds in 33% of GDP in local-government debt at end-2015, up sharply from 21% at end-2013 and 13% at end-2008. Clarity on local-government indebtedness has increased as the central authorities seek to address the issue, but comprehensive data remain lacking. Following a budget law reform in 2014, local governments have been authorised to issue CNY3.2trn in explicit debt to refinance borrowings of off-balance-sheet funding vehicles. The authorities have also set a ceiling for local-government debt for end-2015. Fitch expects general government debt to peak in 2016 at about 54% of GDP.
Fitch believes the Chinese sovereign faces a relatively high level of contingent obligations. The nature of the Chinese economy and financial system is that there is a widespread expectation of sovereign support for state-owned and private-sector enterprises of any material size. Explicit default remains rare.
The rise in local-government debt since 2008 has been part of a broader rise in indebtedness across the economy. Aggregate financing, excluding corporate equity raising, rose to 196% of GDP at end-September 2015, up from 187% at end-2014 and 177% at end-2013. (The ratio was stable around 120% from 2004 to 2008.) Fitch views the rapid rise in leverage in the economy since 2008 as a growing source of systemic risk. However, the growth rate of aggregate financing has slowed to 12.5% yoy in September 2015 from 14.3% in 2014 and 17.5% in 2013. The authorities have acted to curb "shadow banking" activity, which has reduced overall financing growth and led to some re-intermediation of financing back onto bank balance sheets. The risks for the sovereign from the expansion of financing are intensified by the relatively low average standalone creditworthiness of banks in China's system and by the high degree of state ownership and involvement.
China's macroeconomic performance remains a rating strength despite the slowdown in growth. The country's 2011-2015 average growth rate of 7.8% a year is more than double the 'A' or 'AA' range medians, each about 3%. Fitch expects China's growth to slow to 6.3% in 2016 and 6% in 2017, from 6.8% in 2015. The slowdown is being driven by a sharp deceleration in residential real-estate investment after a 2010-2014 construction boom. The unwinding of the real-estate boom poses downside risk to China's growth outlook, although the correction so far has been gradual. Growth prospects are supported by the resilience of the labour market and consumption.
There is a risk of a more disorderly outcome involving a sharper deceleration in growth and the crystallisation of losses in the financial system. The share of investment in GDP at 45.9% is the third-highest of any rated sovereign after Congo and Ghana. The only other countries with shares above 31% are small, mostly poor, commodity-driven economies (both India and Indonesia are at 31%). The authorities have strongly committed to rebalancing the economy since the current top leadership took office in 2012-2013, although progress has been mixed. Financial reform and liberalisation have proceeded relatively quickly - interest rates were fully liberalised in October 2015. However, state-owned enterprise reform has been slower.
The Party Central Committee's Fifth Plenum meeting in October 2015 recommitted the country to the target of doubling China's real GDP by 2020 from the 2010 level, which would require growth of about 6.5% per year on average over 2016-2020, in turn implying a very slow pace of rebalancing. Fitch expects China's process of adjustment, with its attendant risks, to be prolonged.
The Stable Outlook indicates that Fitch views the upside and downside risks to the rating as broadly balanced. The main factors that individually or collectively could lead to rating action are:
- Increased evidence that the economy can adjust smoothly while rebalancing without experiencing a disruptive "hard landing"
- Greater confidence that the debt problem in the broader economy can be resolved without a material negative impact on growth or financial stability
- Widespread adoption of the renminbi as a reserve currency globally
- A sharper growth slowdown than currently anticipated, leading to a materialisation of risks to financial and/or social stability
- A rise in estimated general government indebtedness well above Fitch's current estimate
- Sustained capital outflows sufficient to erode China's external balance-sheet strengths, or undermine financial stability
- A change in policy direction that signalled decreased willingness to tackle the economy's imbalances and vulnerabilities, thereby increasing the risk of an eventual disorderly adjustment
- Fitch assumes China's basic social and political stability is broadly maintained and that regional geopolitical risks do not escalate sharply.
- Recognising China's emergence onto the global stage, the ratings assume the continuation of a broadly open global trade and financial order