HONG KONG, 28 August 2019. Pengyuan International has affirmed the global scale foreign-currency issuer credit rating (ICR) of ‘AA’ and local-currency ICR of ‘AA+’ for the People’s Republic of China. The outlook for both ratings is stable. At the same time, we also affirmed ‘AA’ ratings to three USD denominated bonds issued by the Ministry of Finance of China on October 2018, which have tenor of 5, 10 and 30 years respectively.


China’s ratings are supported by its strong economic fundamentals, moderate general government direct debt, fairly effective monetary and general institutions, strong external position, and very low external liquidity risk. But at the same time, the ratings are constrained by the government’s increasing fiscal pressure, potentially substantial contingent liabilities, and fast-growing macro leverage. 


We expect China’s economy to continue to moderate from high growth in the past decades to a more sustainable pace in line with its long-term economic potential over the next three to five years. In our view, the recently announced policy measures are sufficient to support the country’s 6.2% GDP growth in 2019, but more targeted and precise macroeconomic policies may be needed if external trade conditions further worsen.


We note China’s structural reforms have yielded some progress and improved economic efficiency in recent years, but is still far from sufficient to secure long-term sustainable growth. We agree that more reforms are needed in the financial system, regulatory framework, social security, income distribution, state dominance in key industries, fiscal responsibilities of central and local governments, and taxation etc.

 

KEY CREDIT HIGHLIGHTS

 

Debt burden is moderate but potential contingent liabilities could be high. The debt burden of the general government is moderate in our estimate. Net debt of the general government was about 32.5% of gross domestic product (GDP) at the end of 2018 and is expected to reach 37.3% by the end of 2022, mainly driven by the rapid increase of local government debt. The sovereign’s creditworthiness is also under significant pressure from substantial contingent liabilities that may amount to 39% of GDP in 2019 according to our projection.

 

Economic fundamentals remain strong but the structure needs to be improved. We expect China’s real GDP growth to be 6.2% in 2019 and then moderate to 6% from 2020 to 2021, which is still markedly higher than what is normally seen for such a country at its stage of economic development. In our view, the downside risk of sharp decline in housing construction and delivery remains relatively low from 2019 to 2020 and the impact of the Sino-US trade war on China’s economic fundamentals is not material, given the Chinese government’s policies in response to support the economy. Despite the fact that China’s economy has been gradually shifting towards being more consumption-driven in recent years, both the national savings rate and capital formation ratio continue to stay around 44-46%.

 

External imbalance is expected to be addressed gradually. China remains one of the major net creditor nations in the world, with its net international investment position (NIIP) at US$1.95 trillion in March 2019, and the country’s balance of payments performance is expected to remain solid for its stage of economic development, supported by positive but declining current account (CA) balances from 2019 to 2022 in our estimate. Our base-case scenario projects the CA balance will stay in surplus territory in the next few years, but we think a CA deficit is also highly possible if international trade tensions escalate and domestic consumption rises. We also estimate China’s NIIP to gradually decline in the next few years but remain at 55-75% of current account payments in 2019-2022.

 

Institutions and policies continue to be effective. Both China’s general and monetary institutions are strong for its stage of economic development. China has very high political and social stability. The institutions and policies of China have been quite effective in delivering robust economic and external performance over a very long period of time. However, its institutions and governance lag in some respects. On the monetary side, China’s modest inflation and effective capital controls create substantial space for China to support economic growth with accommodative monetary policy in stress scenarios, although the space for monetary expansion is constrained to some extent by the high macro-leverage of the economy. Average Consumer Price Index (CPI) inflation is likely to stay around 2.6% from 2019 to 2022 in our estimate.

 

Government faces very low liquidity risk. We think the government’s borrowing needs and pattern do not add much to or mitigate significantly its liquidity risk. The government has low reliance on short-term debt or borrowing from non-residents, and the maturity profile of its debt is fairly balanced. Meanwhile, we expect China’s basic balance of payments to remain in surplus in the next three years, while the short-term foreign currency external debt would stay below 30% of the accessible foreign exchange reserve over the same period. This would help reduce the external liquidity risk of the government.

 

Fiscal pressure reaches the highest level in recent years and is expected to stay high. According to our calculations, China’s underlying budgetary deficit will rise to 7.2% of GDP in 2019 from 4.7% and 3.7% in 2018 and 2017 respectively, mainly due to weaker revenue growth as a result of tax cuts and export tax refunds as well as soft land sales. However, the headline deficit reported by the government stayed at 2.8% and 2.6% in 2019 and 2018 respectively. We think the Chinese government still has sufficient fiscal flexibility to stimulate the economy in the next two years but the ever-mounting budgetary pressures will eventually erode China’s fiscal health and add further debt burden to the general government, so more fiscal discipline may be needed down the road.

 

RATING OUTLOOK

 

The stable outlook reflects our assessment that China’s growth potential remains strong; the institutions and policies will continue to be quite adaptive and effective in addressing key challenges; and the Sino-US trade relationship will be rebalanced instead of being completely decoupled.


We could lower the rating if state intervention in the economy becomes much more extensive and such intervention may become a regular feature for years to come, or if the government resorts to aggressive credit expansion to boost economic growth. In such scenarios, the performance and sustainability of the Chinese economy could suffer markedly further down the road.


We could raise the rating if China makes substantial progress in strengthening its institutions and policies, particularly through strengthening governance, improving the division of roles between government and market, and enhancing the availability and quality of key data. This would help China realize its great economic potential in a more sustainable way.


ANALYSTS CONTACTMEDIA CONTACTOTHER ENQUIRIES

Primary Analyst

Tony Tang

+852 3615 8278

tony.tang@pyrating.com

 

Secondary Analyst

Stanley Tsai, CFA

+852 3615 8340

stanley.tsai@pyrating.com

 

Committee Chair

Yun Tang

+852 3615 8297

yun.tang@pyrating.com

media@pyrating.comcontact@pyrating.com



Date of Relevant Rating Committee: 19-Aug-2019

Additional information is available on www.pyrating.com

Related Criteria

Sovereign Rating Criteria (30 May 2018)


 

 

 

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