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Fitch Affirms China at 'A+'; Outlook Stable
July 14, 2017 / 12:09 AM / 5 months ago

Fitch Affirms China at 'A+'; Outlook Stable

(The following statement was released by the rating agency) HONG KONG, July 13 (Fitch) Fitch Ratings has affirmed China's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'A+' with a Stable Outlook. The Short-Term Foreign- and Local-Currency IDRs have been affirmed at 'F1+'. The issue ratings on China's senior unsecured bonds are also affirmed at 'A+' and 'F1+'. The Country Ceiling is affirmed at 'A+'. KEY RATING DRIVERS The affirmation of the ratings and Outlook reflects the following key rating drivers: China's ratings are underpinned by the strength of its external finances and macroeconomic track record. The country's near-term growth prospects remain favourable, and economic policies have been effective in responding to a variety of domestic and external pressures over the past year. However, a further increase in the economy's overall leverage in the context of continued adherence to ambitious GDP growth targets raises the potential for economic and financial shocks and, in Fitch's view, will constrain growth prospects over the medium-term. Large and rising debt levels across China's non-financial sector, combined with the low stand-alone credit quality of Fitch-rated banks in its financial system (as indicated by their average viability rating of 'bb') remain the most significant risk factor for the sovereign rating. The agency expects official aggregate financing (excluding equity) will rise to 208% of GDP in 2017, from 201% in 2016 and 114% in 2008. Fitch's Financial Institutions team estimates that a broader credit measure, which incorporates activity not directly captured in the official series, will rise to around 270% at end-2017. Household debt remains moderate despite its rapid growth in recent years, but China's corporate sector has become the most highly indebted among major economies globally, based on figures from the Bank for International Settlements. External finances are robust in absolute terms and relative to peers, and are expected to remain so over our rating horizon. Capital outflows have fallen sharply since early 2017 due to improved market sentiment, stabilising currency expectations, and various measures to more effectively enforce existing capital controls and scrutinise outward direct investment. The current account also remains in surplus. As a result, foreign reserves have stabilised, rising by USD46 billion so far this year to USD3.06 trillion as of end-June 2017. The potential remains for capital outflow pressures to resume, especially in the context of a strengthening US dollar. Moreover, the effectiveness of capital flow management measures can diminish over time as market participants find ways around them. Fitch therefore forecasts sovereign net foreign assets (SNFA) will decline to 28.9% of GDP at end-2017, down modestly from 29.8% in 2016, but still well above the 'A' median of 5.1%. Internationalisation of the Chinese yuan (CNY) has slowed as measured by its share in global payments and the size of offshore deposits, but its designation as a reserve currency by the IMF in late 2016 provides an important rating cushion shared by only a limited number of sovereigns globally. The IMF's latest Currency Composition of Official Foreign Exchange Reserves (COFER) confirms the results of other market-based surveys that CNY internationalisation has slowed, with its share in global reserves falling to 0.9% in March 2017 versus slightly over 1% in 2015. Ongoing initiatives to increase foreign participation in China's domestic bond market including the recently launched Bond Connect could encourage a rise over time, but may be constrained in the short run by what appears to be an asymmetric opening of the country's capital account, with restrictions on inflows relaxed while those on outflows remain largely unchanged. Growth momentum remains strong, due to the effectiveness of prior stimulus measures, resilient consumer trends, and a more favourable external environment that has nudged up net exports' contribution to overall growth. Real GDP grew by 6.9% in 1Q17, up from 6.7% in 2016, and is well on track to meet the authorities' 2017 target of "around 6.5%". Strong growth momentum has given the authorities renewed confidence to address financial risks, including the release of new guidelines by the China Banking Regulatory Commission to enhance bank supervision and reduce regulatory arbitrage, statements by senior party leaders on the need to strengthen risk prevention, and the facilitation of higher market interest rates by the People's Bank of China to squeeze out speculative activity in the shadow banking sector. The increased focus on financial risks increases the potential for a more decisive shift in policy direction, but has yet to be reflected in official GDP growth and monetary targets. Tighter monetary conditions may lead to slower GDP growth, which in Fitch's baseline forecast will decelerate to 5.9% in 2018, from 6.5% in 2017. Macro-prudential regulations and tighter credit conditions will, in Fitch's forecasts, result in a slowdown in the housing sector and investment spending. Aggregate financing (excluding equity) based on official measures continues to grow at a stable rate of about 12.5% (in excess of nominal GDP growth), but broader measures of financing activity, including municipal bonds and credit extended to non-bank financial institutions have already started to decelerate. Upside risks to our forecasts remain. They include a more sustained improvement in global trade, continued resilience in the property sector, or additional government stimulus measures not factored into our baseline. Even after factoring in our anticipated deceleration, China's five-year average annual growth rate of 6.7% will continue to exceed the 'A' category median of 3.0% by a wide margin. Public finances remain a neutral rating factor. Fitch forecasts general government gross debt (GGGD) of 48.3% at end-2017, up marginally from a year prior, but broadly in line with the 'A' category median of 49.5%. The agency's GGGD figures are roughly 11.5% of GDP, higher than official estimates due to the inclusion of contingent liabilities identified in a previous government audit. The authorities' continued efforts to disentangle local government financing vehicles (LGFV) from public sector balance sheets have resulted in the release of several new guidelines that restrict local governments from extending formal support to LGFVs and reiterate the government's intention that LGFVs be treated by creditors on a stand-alone basis. Nevertheless, the continued prevalence of implicit support as exemplified by a minimal widening of yield spreads between local government and LGFV bonds highlights the implementation challenges at the local level, and increases the potential for fiscal shocks. Fitch's base-case scenario continues to assume a slowdown in China's medium-term growth trajectory, consistent with declining potential growth. Moreover, rising financial fragilities associated with the continued rise in system-wide leverage increase the risk of a sharper and more disruptive slowdown. However, in the agency's view, the government's still-pervasive ownership and influence across creditors and borrowers in the financial system broadens the spectrum and effectiveness of policy tools available to mitigate such an outcome. China's levels of income and development remain low compared with peers, even after nearly 40 years of rapid growth since market-oriented reforms began in 1978. Average income is around USD8,387 at market rates, or USD13,130 at purchasing-power parity, well below the 'A' medians of USD19,259 and USD27,714 respectively. Standards of governance also lag 'A' category peers based on standard international surveys including the World Bank's Governance Indicators. These fundamental credit weaknesses weigh on the ratings. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns China a score equivalent to a rating of A+ on the Long-term FC IDR scale. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows: - External Finances: +1 notch, to reflect strengths in China's external finances not captured in the SRM. The adjustment from a +2 notch adjustment to +1 notch within External Finances reflects the inclusion of the CNY's reserve currency flexibility score in the SRM following its designation by the IMF in late 2016 and the consequent removal of the need to adjust for that factor in the QO. - Structural Features: -1 notch, to reflect weaknesses in the banking sector for which the average Viability Rating is two categories below the sovereign rating. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The main factors that could lead to negative rating action, individually or collectively, are: - A continuation of policy settings that result in a further build-up of the economy's imbalances and vulnerabilities. - An adverse macroeconomic or financial shock that weakens medium-term growth prospects or negatively affects public finances. - Sustained capital outflows sufficient to erode China's external balance sheet strengths, or undermine financial stability. The main factors that could lead to positive rating action, individually or collectively, are: - Greater confidence that the debt problem in the broader economy can be resolved without a material negative impact to growth or financial stability. - Increased evidence that the economy can rebalance smoothly. - Widespread adoption of the Chinese yuan as a reserve currency globally. KEY ASSUMPTIONS - The ratings assume the continuation of a broadly open global trade and financial order. - Fitch assumes China's basic social and political stability is broadly maintained and that regional geopolitical risks do not escalate sharply. Contact: Primary Analyst Andrew Fennell Director +852 2263 9925 Fitch (Hong Kong) Limited 68 Des Voeux Road Central Hong Kong Secondary Analyst Stephen Schwartz Senior Director +852 2263 9938 Committee Chairperson Tony Stringer Managing Director +44 20 3530 1219 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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