Mar. 19 2019 — China's leaders are showing restraint in the face of economic uncertainty. Key policies and targets announced at this month's annual government planning sessions indicate a moderate stimulus will unfold in 2019. S&P Global Ratings believes the government is reserving some policy buffers to handle potential volatility ahead, considering U.S.-Sino trade talks are ongoing, and recent deterioration of some indicators in recent months.
Monetary, fiscal and sector-reform targets announced at China's 13th National People's Congress (NPC) and Chinese People's Political Consultative Conference ("The Two Sessions") indicate a more gradualist approach compared with sharper clampdowns on shadow banking and reforms implemented over the past two to three years.
China's Not Ready To Go Below 6%
We believe China's aim is to stabilize the economy without conducting a major credit expansion as in previous stimulus cycles. Government leaders announced a 2019 GDP growth target of 6%-6.5%, considerably more flexible than 2018's target of 6.5%. "The economy must not be allowed to slip out of a reasonable range," Premier Li Keqiang said at the NPC. In our view, the government is prepared for a further slowdown but will moderate any sharp deceleration.
The stimulus will be relatively moderate and focus on three key areas: tax cuts, some relatively mild infrastructure stimulus, and more accommodating monetary conditions.
A doubling-down on tax stimulus: planned 2019 cuts 50% bigger than in 2018
Cuts to taxes and fees worth Chinese renminbi (RMB) 2 trillion (US$300 billion) were announced at the Two Sessions, a considerable increase from the RMB1.3 trillion in tax reductions offered in 2018. While we estimate the actually cuts will likely be lower at RMB1.5 trillion (see "How Can China Cut Taxes And Maintain Low Budget Deficits?," published on RatingsDirect on On March 12, 2019), this is still sizable and reflects an important shift in fiscal philosophy.
We estimate the reduction in value-added taxes (VAT) could reduce the corporate tax burden by around RMB850 billion. Some companies will also get relief from proposed cuts of 10% on commercial electricity, and reduced costs on rail, port, or toll-road fees. Corporate contributions to social security funds have also been reduced; however, this relief is likely to be largely offset by tougher enforcement of the widely evaded tax.
What's the credit impact of tax cuts on corporates?: Manufacturing, mining, and retail sectors are among the top beneficiaries of a lower VAT. Tax cuts could improve corporate cash flow, but may not be sufficient to offset weakening consumption and capital spending. Further deterioration of consumer confidence and business sentiment could pressure China corporate's debt-servicing capabilities and constrain financial flexibility, in our view. On the whole, we expect corporate deleveraging in 2019 to stall or even reverse the deleveraging trend in the past two to three years.
Don't expect 5,000 new railways…but a moderate infrastructure stimulus is on the cards
Government leaders announced fairly tamed infrastructure investment plans. For example, the target for spending on railway, roads, and waterways is flat from last year. Local governments will continue to face restrictions on issuing off- balance sheet debt through local government financial vehicles (LGFVs) to fund spending. However, they can apply to issue "special-purpose" infrastructure bonds under a centrally administered system. The 2019 quota for new special-project bonds is RMB2.15 trillion, up RMB800 billion, or 60% over last year. We estimate infrastructure investment growth of 8%-10% in 2019, compared with 3.8% last year.
What's the credit impact on LGFVs? We believe the central government will maintain a strict attitude toward local government's implicit debt growth, which would constrain over-spending through LGFVs. However, authorities are easing financial conditions on this sector, to reduce immediate refinancing risk in a year of record maturities for LGFVs. We also expect local goverments will be permitted to issue bonds to swap out maturing LGFV debt--especially debt classified as contingent. This could lower funding costs in the short run and increase transparency in the long term.
What's the credit impact on infrastructure firms? Overall, instead of large-scale plans, the government will earmark spending for improving weak links in the economy and developing key projects in target areas, such as technology infrastructure (including a 5G network, and rural fiber broadband) and environmental protection. In our view, sectors that will benefit from higher infrastructure spending include engineering and construction (E&C) companies, commodity producers, equipment manufacturers, and technology, and telecommunications.
Massive credit growth is unlikely
The government targets to keep the money-supply and aggregate financing (a broad measure including some equity financing) consistent with nominal GDP growth. This indicates moderate credit easing compared to the focus on financial deleveraging in 2018, when the expansion in M2 growth was lower than nominal GDP growth. This moderate softening indicates a more cautious stance from the People's Bank of China after multiple monetary-easing operations since last year.
We believe the government will try to hasten credit dissemination to favored sectors, particularly micro and small enterprises. That means more targeted monetary easing measures on privately owned enterprises (POEs) and major governmental projects.
What is the impact on credit conditions? Funding conditions should improve for good-quality companies and LGFVs. However, financially weak companies will still find it difficult to issue bonds. It's too early to say whether this year's rising stock market will widen financing options. Rebounding equities mitigate the risk for companies that pledge shares for loans, a common practice for POEs and other companies without strong banking relationships. However, given economic uncertainty, a recovery equity financing, including the IPO market, is far from guaranteed.
Reforms Will Also Be Restrained In 2019
Economic and employment stability is the priority in 2019. Reforms will move ahead only to the extent that they do not seriously compromise these priorities. We note a recent easing of some restriction on property markets or alternative-financing markets. That said, we expect state-owned enterprises (SOEs) in overcapacity sectors will remain under official mandate to deleverage. And that LGFVs will continue to transition to more commercially viable business models, rather than relying on government revenues and support. We don't anticipate a large relaxation on housing policy, unless economic growth declines more sharply than expected.
A neutral impact for the property market
Officials at the Two Sessions promised more affordable-housing construction and "shantytown" renovation. However, no specific targets on units were announced. This is unusual; in most years since 2012, targets have been set. This may signal a weakening growth of property investment in 2019 and propel a slowdown in property sales in lower-tier cities. Against this, the overall tone on the property sector has softened and we note city-specific property policies have loosened a bit in recent weeks. This together with improved credit conditions for mortgage and corporate lending should forestall a major decline in property sales in 2019. In our view, residential property sales will decline by no more than 10% in value.
What is the credit impact on developers? Declining sales will put pressure on cash flow and internal liquidity, particularly in the first half of the year. Rated developers are likely to outperform the industry average due to better sales execution and geographic diversification. However, we estimate sales growth for rated developers will also likely remain mild, with average growth of 15% in 2019 compared with more than 50% in 2018. Sector refinancing risk has slightly reduced in the near term thanks to better funding conditions both onshore and offshore. However, smaller developers remain vulnerable due to weak sales and still constrained financing windows. Given large maturities this year, onshore defaults of property companies remain likely.
SOE deleveraging to continue; "weak links" could be vulnerable.
After last year's jump in bond defaults, which was driven by weak private-sector firms, we expect "zombie" SOEs could be a surprise weak link this year. In December 2018, the National Development and Reform Commission issued a directive for SOEs to further reduce leverage. This will include the removal or restructuring of "zombies"--unprofitable enterprises kept afloat by infusions of debt or equity. We expect SOE reform to remain on track, aided by further mix-ownership and debt-equity swaps.
What is the credit impact on SOEs? Long-standing loss making SOEs that rely on continuous refinancing for their sustainability could face potential higher credit risk in our view.
For POE support, uncertainty lies in the execution.
China sees support to private enterprises as a means to stabilize employment and control financial risks. However, there are many uncertainties in policy execution, in our view. For example, it is still unclear how banks will balance increasing loans to micro and small enterprises while controlling bad-debt growth. The longstanding market assumption of implicit SOE guarantee also continues to put POEs at a competitive disadvantage.
What is the credit impact for POEs? The credit divergence between large and small companies will widen even further in terms of funding conditions and corporate default rates will continue to rise this year.