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Sector Roundup Asia-Pacific: Slowdown Gradually Flowing Through


Overall: The region’s economic slowdown continues to keep ratings on nonfinancial corporates under some pressure. That said, favorable momentum on some sovereigns’ credit profiles has kept financial services and government ratings on a more positive footing.

Assumptions and risks: Regional GDP growth is expected to continue slowing in line with China’s. Financing conditions are likely to be choppy because of lender nervousness despite the Fed possibly cutting rates again. The clear-and-present risk is an escalation of the U.S.-China strategic conflict.

What to look for: Despite low official rates, more cautious creditors could make it increasingly difficult for lower-rated and emerging market issuers to refinance, implying liquidity risk.

The overall net rating outlook bias is largely flat at positive 1.5% in August 2019 from +1.4% in May 2019 (see chart 1 and table 1). There is a slight improvement in Australian banks' credit profiles and favorable momentum in some government credit profiles that helped raise the bias ratio for financial services and governments to +12% from +8%. However, nonfinancial corporate sectors are challenged by slowing economic prospects, uncertainty over business conditions, and tight sales margins. The corporate net ratings outlook bias declined to negative 7% from -4%.

Corporate. Autos, capital goods, consumer products, technology and telecoms have the most negative rating bias. Weak sales are cutting automakers' earnings. China’s economic slowdown and subdued global capex needs in the auto, electronics, and construction sectors are hitting profitability and cash flow of capital goods companies. Intense competition, product development, and higher input costs are squeezing consumer product margins. Tariffs on Chinese exports of major IT products to the U.S. will further dampen technology demand. Intense competition amid ongoing large investments has affected telecom companies.

Financial institutions and insurance. High private sector debt and elevated asset prices pose threats to banks. The GDP outlook for Asia Pacific is slowing but not to an extent that causes significant concerns for most bank ratings. Forex and investment market volatility could dent insurers' profitability.

International public finance. Fiscal expansion poses risks to Chinese local governments’ budget position. Australian local governments’ fiscal positions are weakening as consumption and transaction taxes soften.

Sovereign. Credit risks from trade tensions and abrupt capital-flow reversals have rebounded. Risks to economic and fiscal performances could increase if global economic growth slips materially.

Structured finance. Stable employment in major securitization markets will keep arrears and defaults low.

(We calculate the net rating bias by deducting the percentage of negative outlooks and CreditWatch listings against the percentage of positive outlooks and CreditWatch listings. A minus figure indicates that the percentage of negative outlooks and CreditWatch listings exceeds the percentage of positive outlooks and CreditWatch listings; and a positive figure, vice versa.)

A summary of assumptions and risks by industry sector is given in table 2.

Chart 1

Net Outlook Bias Distribution Of Asia-Pacific Issuers By Sector, Aug 30, 2019

Net Outlook Bias Distribution Of Asia-Pacific Issuers By Sector Chart

Table 1

Net Rating Bias Of Asia-Pacific Issuers By Sector, Aug. 30, 2019

Net Rating Bias Of Asia-Pacific Issuers By Sector Table

Table 2

Summary of Key Assumptions and Risks for Asia-Pacific's Industries

Summary of Key Assumptions and Risks for Asia-Pacific's Industries table

Summary of Key Assumptions and Risks for Asia-Pacific's Industries table


Weak Market Likely To Increase Rating Pressure

Weak Market Likely To Increase Rating Pressure Chart

Key Takeaways

− Weak sales are cutting Asia-Pacific automakers' earnings.

− Negative outlook bias has been increasing backed by severe business circumstances. 

− Automakers' solid financial standing with low debt remains a support for credit quality.

What's changed?

Rating pressure intensifies. Demand for new cars has notably weakened amid strong competition in the U.S. and China. Stress is also cranking up due to high research and development (R&D) expenses for new technologies.

Key assumptions

Low growth in main markets. We expect growth in light vehicle sales in the U.S. and China to decline by around 3% respectively in 2019, squeezing margins. Sales growth is likely to be flat in Europe.

Strong updraft for costs. R&D expenditure for technologies such as new electrification features and connectivity options should remain high. Material costs will also likely increase.

Key risks

Weakness in major markets. A sharp decline in global sales would significantly affect APAC automakers' earnings. It will also hurt the asset quality of captive finance operations.

Higher tariffs in the U.S. Potential tariffs on U.S. auto imports would materially affect Japanese and Korean automakers. Meanwhile, establishing local production capacity in the U.S. will take some time to implement.

More spending for new technologies. Tighter environmental requirements could lead automakers to accelerate investment in electrification and other new technologies.

What to look for

Recovery prospects in China market. We expect prolonged weakness in the China market to result in even stronger downward pressure on the creditworthiness of Asia-Pacific auto manufacturers. 

Building Materials

Demand Uncertainty Remains The Key Risk

Key Takeaways

− Steady economic growth and infrastructure investment underpin a stable credit trend, though the risk is to the downside.

− Prices remain resilient, while companies are likely to deleverage further and control capex.

− However, uncertainty over demand growth is rising due to the U.S.-China trade dispute.

What's changed?

Rising demand uncertainty. Companies' performance has remained robust. However, the continuing U.S.- China trade dispute brings higher downward pressure for demand growth in 2019.

Key assumptions

Curtailed capex and investment. We expect companies to restrain their capital expenditure (capex) over the next two years. Aggressive mergers and acquisitions (M&A) are unlikely to occur. Most companies are deleveraging through asset sales and debt repayment.

Solid infrastructure investment. Continuing economic growth will support infrastructure investment and construction activity. However, with a more gloomy economic growth outlook, the risk is to the downside unless governments choose to lift infrastructure investment to support the economy. The property industry remains robust in general.

Key risks

Demand slowdown. As the impact of the trade dispute on global economic growth deepens, demand could slow, reigniting overcapacity issues. The Chinese government was approving infrastructure projects in late 2018 and early 2019 to support demand. How much of the investment materializes remains to be seen. If the U.S.-China trade dispute drags on China's economic growth, the government may support the economy through infrastructure spending, which rebounded 4.2% (year on year) in August from a low of 3.8% in July.

Liquidity and refinancing risks. These remain key risks for smaller players, amid a tightening capital market and slack demand.

If the credit cycle turns. With tighter credit conditions and a potential decline in GDP growth, investments in the region could fall significantly, reducing prices and demand, absent any government support.

What to look for

Refinancing and demand uncertainty. Liquidity and refinancing conditions are stabilizing while oversupply remains a short-term risk for pricing, particularly in China. Price weakness could dampen profitability and amplify liquidity risks for smaller players. More importantly, the development of the trade dispute and its spillover effect will have a significant impact on the sector.

Capital Goods

Economic Slowdown Threatens Weak Companies

Economic Slowdown Threatens Weak Companies chart

Key Takeaways

− China's economic slowdown and subdued global capex needs in auto, electronics, and construction sectors hit profitability and cash flow.

− Weaker issuers may feel the strain but investment-grade issuers can withstand the slowdown.

− Credit metrics are likely to remain under pressure in the second half of 2019, and refinancing and liquidity risks will persist for speculative-grade issuers amid volatile forex and capital markets.

What's changed?

Increasing net negative rating bias. The intensifying U.S.-China trade dispute will continue to dampen the investment appetite and weaken the credit measures of Asia-Pacific capital goods issuers we rate, notwithstanding the Chinese government's stimulus plans.

Key assumptions

Weakening end-markets in China. Aggravated conditions in China's electronics (smartphones, semiconductors, and digital devices), auto, and infrastructure sectors cast doubt on future capital expenditure and investment decisions. Government stimulus will alleviate the impact, somewhat.

Cost-management efforts. Despite the weakening industrial and financial market sentiment, continued business restructuring and cost-cutting could mitigate downward pressure on profits.

Key risks

Deleveraging to stall. Deleveraging in rated capital goods companies will stall, mainly because of a slowdown in earnings growth rather than profligate spending or borrowing in China and for weaker players.

Refinancing and interest rates. High debt maturities in 2019 will put China's weaker speculative-grade companies under refinancing pressure.

If the credit cycle turns. Corporate spending and exports will remain sluggish not only in China and Southeast Asia but also Japan and Korea, in line with worsening credit metrics for the sector. Small, narrowly focused companies will be more vulnerable.

What to look for

Slowdown widens gap between weak and strong. Given the economic slowdown in China and Southeast Asia, and the materializing negative impact from the trade dispute between the U.S. and China, we expect weaker end-markets to depress the sector's profitability. This will strain companies with weaker credit quality, but strong investment-grade issuers can withstand the adversity.


Petrochemical Spreads Continue To Fall Amid Sluggish Demand

Petrochemical Spreads Continue To Fall Amid Sluggish Demand Chart

Key Takeaways

− Weakening global demand amid trade tensions and China's slowdown continues to squeeze polymer spreads.

− With global capacity expansion ahead, we expect petrochemical spreads to fall over the mid to long term.

− Negative naphtha-crude spreads indicate a slowdown in petrochemical sector demand. 

What's changed?

Demand is slow and supply is ample. Polymer product spreads continue to weaken, mainly due to slowing demand from China, while capital expansion continues. With key product spreads contracting, we expect softer earnings for Asia-Pacific chemical companies in 2019.

Key assumptions

Global expansion plans. Around 20 million tons of global ethylene capacity expansion is expected to materialize over the next three years, driven by Asian and North American petrochemical producers.

Benign demand. Historical global ethylene demand growth has been around 3 million–5 million tons per annum, which is insufficient to offset global expansion over the next three years.

Key risks

China slowdown. Capacity utilization rates could weaken for the chemical sector with ongoing overcapacity and slowing economic growth in China.

Rising oil prices. Amid a volatile oil price environment, an oil price jump to beyond US$90 per barrel could pose a risk to a few chemical producers, because hikes in raw material costs may not be fully passed on to product prices.

If the credit cycle turns. Commodity chemical companies are exposed to the inherent earnings volatility of the sector. Key points to monitor are their investment cycle, product diversification, and cost competitiveness.

What to look for

Polymer spreads to decline on supply glut. We expect petrochemical product spreads to decline in the second half of 2019, as supply should outpace demand. That said, delays in expansions are possible, which could be a mitigating factor.

Consumer Products

Rise Of Middle Class Boosts Sales

Rise Of Middle Class Boosts Sales Chart

Key Takeaways

− The rise of the middle classes will lift consumption, albeit at a slowing pace, and support retail sales.

− Intense competition, product development, and higher input costs may squeeze margins.

− Discipline over investment, new products, and operating efficiency will differentiate credit quality.

What's changed? 

Escalated Sino-U.S. trade tensions. The direct impact of tariffs on all Chinese goods exported to the U.S. would be manageable for most rated consumer product companies in China, given their focus on domestic consumption. However, the potential impact on consumer sentiment and supply chains may pressure consumer product companies' growth prospects and profitability.

Key assumptions

Consumption driving growth. Growth in cosmetics--in premium skincare products and healthcare--should continue to outpace GDP. However, growth in food staples and low-end products might hit low single digits.

Higher raw material prices and selling costs. Potentially higher input costs and rising promotional expenses may pressure profitability. Competition to develop products to meet changing tastes and online shopping preferences will remain intense.

Key risks

Debt-funded M&A. In China, market fragmentation and companies' desire to control high-quality raw material sources or better brands could spur M&A. Japan's major food, beverage, and tobacco companies will continue to seek growth in emerging markets, which could increase foreign exchange risk.

Rapidly changing consumer tastes. Companies' adaptability to shifts in consumer tastes, rising online sales, online to offline services, and mobile payments are key to survival.

If the credit cycle turns. Any abrupt sales decline could further pressure earnings. Small companies with weaker balance sheets or limited access to credit markets could face rising refinancing risks and deteriorating growth.

What to look for

Impact from Sino-U.S. trade tensions. Second-order impacts on consumer sentiment and supply chains could develop into credit negatives if trade tensions prolong. Any further retaliatory action on U.S. imports by the Chinese government could affect consumer product companies that import from the U.S.

Financial Institutions

Stable Profiles, Some Threats

Key Takeaways

− Most rating outlooks are stable.

− The greater number of positive outlooks compared to negative outlooks is mainly due to the impact of the positive outlook on the Japan sovereign rating on systemically important Japanese banks. But for this factor, the net positive bias would be only 1%, not 11%.

−  High private sector debt, elevated asset prices, and property sector risks pose threats.

What's changed?

GDP slowing. GDP growth forecasts for end-year 2019 are now lower due mainly to increasing trade uncertainties which is causing numerous central banks to embrace more dovish interest rate policies.

Banking industry risk trends in Japan weaker. Persistent low-profitability in the ultra-competitive Japanese banking sector is contributing to weaker standalone bank credit quality in Japan.

Australian major bank outlooks stable. Negative outlooks on the Australian banks were recently revised to stable, following the regulator’s announcement concerning loss-absorbing capital.

Key assumptions

Slower macroeconomic outlook. The cyclical downturn in Asia-Pacific trade continues to be manageable, at current rating levels, for most regional financial institutions, but is contributing to downward rating pressures.

Governments remain supportive. A point of contrast with Western Europe and the U.S. is that systemically important banks in most Asia-Pacific jurisdictions will likely benefit from extraordinary government support, in the unlikely event it was required.

Key risks

High debt, elevated asset prices. High private sector indebtedness and high asset prices amid a protracted low interest rate environment across much of the region. These factors set the stage for a potential deterioration in credit quality.

Property sector risks. A meld of property risks across much of Asia-Pacific banking--including banks’ high exposure to property, high property prices, and corporate-sector property risks--are a risk for future bank asset quality. 

What to look for

Asset quality, capital, and earnings relatively stable. Aside from India, nonperforming loans should remain relatively low in most jurisdictions in 2019. The regional slowdown may mean banks are challenged to repeat similar good asset quality, by global standards, in 2020. Earnings and capital should generally remain supportive of ratings at current levels.


Profit Growth To Outpace Revenue Gains

Key Takeaways

− Macau gaming revenue forecast lowered on weaker VIP growth than we had expected, though this is partially offset by strong mass performance that beat our expectations.

− For the rest of Asia-Pacific, gaming revenue growth should be in line with that of GDP.

− Casino operators' financial discipline in capital spending and shareholder distributions will differentiate rating outlooks.

What's changed?

2019 Macau gaming revenue forecast to grow 0%-4%. We expect lackluster performance in VIP due to flows into premium mass, regional competition to persist. However, we expect the mass market segment to maintain its momentum.

Key assumptions

Steady profit margins. EBITDA margins should remain steady or improve slightly due largely to mass-market segment growth and rising consumption at newly opened casinos in Macau.

Japan integrated resorts still a few years away. We do not expect Japanese integrated resorts to hit the scene before 2024, although we expect the selection of operators to be announced sometime between the second half of 2019 and the first half of 2020.

Asia-Pacific gaming growth in line with GDP. For the rest of Asia-Pacific, we expect gross gaming revenue to increase broadly in line with GDP growth. Rising disposable incomes and improving infrastructure continue to be key longer-term growth drivers.

Key risks

Chinese regulation. Any unfavorable regulatory change by the Chinese government over capital controls could swing growth of the VIP segment across the region, given that most VIP customers are from China.

Gaming concession expiry. Macau's gaming concession will expire in June 2022 for all six operators, posing a risk for operators. However, we do not presume any existing operators will lose their gaming licenses during rebidding.

If the credit cycle turns. Any abrupt decline in economic activity or gamer sentiment could pressure revenues.

What to look for

Debt-funded expansion, shareholder returns. A few new major gaming casino projects remain in Asia until Japan's integrated resort openings. Operators' financial discipline on shareholder distributions remains key.


Market Volatility Threatens Profits

Key Takeaways

−Forex and investment market volatility could dent insurers' profitability.

−Evolving regulatory and accounting frameworks may alter business, capital management strategies.

−U.S.-China trade tensions present both risks and opportunities for Asia-Pacific insurers.

What's changed?

Market volatility. Recent hikes in equity market volatility on rising trade tensions will dent some insurers' profits. Forex volatility may affect insurers in Taiwan, Japan, and Korea with sizable overseas investment exposure. Lower-for-longer interest rate trends may hike loss reserves provisioning, impacting earnings. 

U.S.-China trade tension. While fundamental demand for insurance remains strong given still-low penetration within the region, slower economic activity may cut demand for marine cargo and trade credit insurance.

Key assumptions

Capital buffers. Built up retained earnings and moderate liability guarantees had shored up capital buffers to absorb recent market volatility. Underwriting capacity and no major catastrophes are keeping premium rates low for P&C insurers and reinsurers. Higher acquisition and compliance costs may dent profits.

Asset growth. Chase for yield, amid volatile investment markets, may prompt insurers to undertake more credit risks. In China, insurers' greater involvement in equity markets and investment in banks' perpetual bonds present downside risks. The higher correlation between insurers and banks increases sensitivity to economic risks with mounting concentration risk.

Key risks

Offshore expansion. More aggressive overseas investment exposes insurers to greater balance-sheet volatility. Insurers with unhedged offshore buys could see forex volatility. Amid low interest rates, we expect hedging costs to rise.

Nonmodeled risks. Urbanization and changing weather patterns will require insurers to revisit their catastrophe pricing assumptions, potentially affecting reinsurance arrangements. Recent typhoons in Japan and China's coastal cities will mean a review of geographic exposures and may increase reinsurance costs.

Regulatory changes. Evolving regulatory developments may lead to changing business and investment strategies. Changing regulations will mean increasing compliance costs and human resources.

What to look for

Typhoon season 2019. As we step into Q4, insurers remain exposed to the residual typhoon season.

Metals And Mining

Key Raw Material Prices Feel The Strain

Key Takeaways

− Weaker coal prices will test the resilience and liquidity of highly leveraged coal producers.

−The credit quality of steel producers should generally hold even through volatile and still elevated iron ore prices, and record Chinese steel production.

−Base metal prices are mixed--copper and aluminum prices are expected to rise while zinc and iron ore prices could decline on supply surplus.

What's changed?

Global growth slowing. Softer, but sustainable, Chinese demand growth and the U.S.-China trade dispute could increase volatility in metal demand and prices. This, in turn, will continue to keep their cash flows soft.

Key assumptions

Softer metal prices. The prices of key bulk commodities--including iron ore and coal--are slipping, partly due to demand softness and supply increases. Iron ore prices have stayed elevated as the top-three producers continue to face supply disruptions. Steel, zinc, aluminum prices will likely stay soft going into the second half of 2019 as global growth worries mount. Gold and copper prices are likely to trend up as risk aversion supports gold prices while higher production costs and supply disruptions push copper prices up.

Profits over volume growth. Lacking any new large project starts, production will likely remain relatively stable in 2019-2020. Focus remains on efficiency gains and profit maximization rather than scale growth.

Key risks

Profits under pressure. Key input costs--especially energy costs (oil and coal) and bulk commodities such as iron ore prices—should soften. End product prices for steel could soften more, compressing margins. In addition, mining costs are somewhat stagnant, meaning end product price compression would dampen profitability. 

Limited new investments. No new large projects are on the horizon, keeping free cash flow under control. Shareholder returns are prudently managed while large debt maturities are unlikely to affect refinancing prospects.

If the credit cycle turns. We expect liquidity to dry up fairly quickly--especially for small, concentrated or leveraged miners e.g. smaller coal miners.

What to look for

China and global trade. Given that China accounts for over half of global demand for raw materials, any weakening in its downstream sectors could pressure this sector. If trade uncertainties affect the real economy, it could hurt global demand and commodity prices.

Oil And Gas

Rising Pressure On Oil Prices

Key Takeaways

−We assume Brent oil price would average US$60/barrel for 2019, 2020, and US$55/barrel long-term.

−Asian oil companies' metrics will be largely stable in 2019-2021. IMO 2020 could be a positive.

−Lower global crude demand due to trade tensions and rising supply especially from the U.S. could pressure oil prices. Geopolitical risk is a wild card.

What's changed?

Rising pressure. The U.S.-China trade dispute is leading to a gloomier global economic outlook. Rising U.S. oil production adds to the pressure. Geopolitical risks (including OPEC's actions) could lead to an oil price rebound. Cost control and cash deployment will set oil companies apart in terms of credit quality, especially during difficult times.

Key assumptions

Robust credit metrics. Oil companies have significantly reduced operating costs and capital spending during the last price cycle trough. Further, cash flow and credit metrics improved when prices recently recovered. However, we expect China's oil companies to increase capex in 2019 in response to President Xi's call for higher domestic spending to raise energy supply.

Stable refining margins. Amid lower crude oil prices in 2019 than 2018, we expect refiners to maintain lower but healthy margins and robust operating cash flow, maintaining their credit metrics. In general, we have not factored in any potential positive impact on refining margins due to the International Maritime Organization new requirement of sulfur content effective from Jan. 1, 2020.

Key risks

Liquidity and refinancing risks. If credit conditions tighten due to slower economic growth or the trade dispute, oil companies, especially smaller ones, could face heightened liquidity and refinancing risks.

Structural change in oil demand growth. Although electric vehicles are a longer term trend, many governments are already promoting electrification to replace fossil fuel vehicles, which will constrain long-term oil demand. Any technology breakthrough will cast doubt on long-term demand, pressuring oil prices.

If the credit cycle turns. With tighter credit conditions and a potential decline in GDP growth, oil prices and demand could decline.

What to look for

Demand and refinancing risks. For small players in particular, refinancing risk remains if oil prices weaken. Banks may become more cautious about their exposure to the sector. A global economic slowdown could crimp oil demand and prices, leading to weaker cash flows and credit metrics.

Public Finance

Fiscal Expansion Heightens Risks

Key Takeaways

−China's fiscal expansion poses risks to the budgetary performance and debt position of LRGs.

−Australian local governments' fiscal positions are weakening as consumption and transaction-based taxes soften. Governments are ramping up infrastructure spending, driving debt to record levels.

−Slower economic growth prospects pose the main risk.

What's changed?

High positive bias declining. Positive rating outlooks on sovereign ratings of New Zealand and Japan drive
a current positive bias, but rising leverage risks--especially for local and regional governments (LRGs) in
China--are cutting into that positive bias.

China's investment yet to revive. China remains highly dependent on investment-driven growth, but new investment growth remained subdued despite loosening monetary policies and accelerating fiscal expansion.

Key assumptions

Chinese LRGs' modest investment growth. LRGs' new bond issuance will continue to rise for refinancing and new investment, while the authorities will control LRGs' overall debt burden by restricting LRGs from further extending off-budget borrowings. Public investment growth, after considering on-budget and off-budget borrowings, will therefore stay modest.

Most Australian states to increase borrowing. Record infrastructure spending plans will hike borrowing needs, especially as tax revenue slows. Weaker domestic conditions are reducing growth in goods and services taxes, while falling property prices are leading to conveyance duty write-downs. New accounting standards are resulting in operating leases being recognized as debt.

Key risks

Revenue pressure. China's authorities have initiated a series of tax cuts to promote economic growth. Some LRGs may find their revenue basis and budgetary balances coming under greater stress.

Off-budget borrowing to support growth. If China's economic growth decelerates rapidly, LRGs' off-balance sheet debt may spike again, resulting in weaker transparency and another hike in LRGs' debt burden.

If the credit cycle turns. Tighter credit conditions could weigh on economic growth, LRG's budgetary balance, and liquidity buffers.

What to look for

Policy shifts if growth weakens. LRGs' response should economic performance weaken more than we expect will be to push for more aggressive fiscal expansion, affecting longer term credit trends in the LRG sector.

Real Estate Development

Financing Policies Tightened To Cool China's Land Prices

Key Takeaways

−China's sales growth and land sales have cooled moderately due to policy tightening around financing.

−Credit profiles will continue to diverge for players with different land reserve sufficiency as financing becomes more difficult.

−Record high issuance volumes offshore have largely alleviated immediate refinancing risks, but maturity profiles continue to shorten.

What's changed?

Sales growth momentum has slowed. Driven by tighter funding, Chinese sales growth is tapering from its peak in April. Land sales have also cooled. The trend for a rising premium above the base auction price ceased in July. 

Key assumptions

Price increase will be the key sales growth driver. National cumulative residential sales growth was 9.2% during the first seven months, from April's peak of 10.6%. We expect growth to continue to be solely supported by price increases, as sales remain flattish.

Policies around land financing will hold tight. Since May, the Chinese government has tightened financing from all channels to cool land prices. That said, we believe a reasonable volume of liquidity will be available, particularly for refinancing, as sector growth is needed to support a slowing economy.

Key risks

Pressure for land replenishment. While many developers could scale back land acquisitions, those lower rated that are short of land reserves will be pressured to replenish.

Policy swing or uncertainties. Large-scale companies are likely to benefit as they continue to have better financial flexibility, lower funding costs, and generally sufficient land reserves.

Policy uncertainties. Recent policies are focused on land financing and do not affect overall supply and demand. However, excessive tightening could bring uncertainty to, and dampen, longer-term sales.

What to look for

The effectiveness of recent policies on the land market. Some Chinese property developers have begun slowing land acquisitions. If the land market does not stay on its cooling path, policies could further tighten.

Real Estate Investment Trusts

Financial Strength To Absorb Shocks

Key Takeaways

−The sector is largely stable due to REITs' solid market positions.

−Asia-Pacific REITs' prudent financial stance has provided a buffer for ratings to withstand debt-funded growth and economic shocks.

−A sharp increase in interest spreads will have limited impact.

What's changed?

Stable credit quality. Credit quality has moderately declined but remains within tolerances.

Key assumptions

Solid revenue growth. Revenue growth should remain stable given solid economic growth, though risks of a slowdown are increasing. Growth in gateway cities is likely to remain in the low single-digit range.

Limited refinancing. Most real estate companies have built a cushion in their credit metrics, along with a largely fixed-rate capital structure with limited refinancing needs, to withstand modest interest spread hikes.

Financial discipline. We expect financial policies to remain fairly disciplined, supporting profiles. This is despite somewhat higher appetite for share repurchases or development projects to enhance growth given limited acquisition prospects.

Key risks

Widening interest spreads. Interest spreads widening dramatically is a key risk because it could pressure valuations in several markets. We tested the global sector for interest rate increases of 100 basis points (bps), 200 bps, and 300 bps.

Digital disruption: Disruption in retail and the development of co-working rental alternatives are forcing some REIT landlords to reshape their leasing offer--a trend that we expect to continue throughout 2019. 

If the credit cycle turns: A potential liquidity pullback from trade-affected economies could reduce debt availability for real estate entities in gateway cities, making it difficult to source debt and refinance.

What to look for

Erosion of financials. Adherence to prudent financials is key to rating stability amid lumpy debt-funded growth. An accelerating trend to increase debt without a commensurate improvement in funds from operations (FFO) could increase credit risks.


Slower Sales Growth, Squeeze On Profitability

Key Takeaways

− Consumer sentiment is likely to weaken more than we previously assumed due to the intensified trade dispute and weakening economies in Asia-Pacific.

− The credit quality of Asia-Pacific's retailers has stabilized after recent rating actions, but could be under pressure again due to vulnerable earnings.

− Offline retailers' profitability won't recover with softer demand, while online retailers are still resilient.

What's changed?

Subdued consumer sentiment. Consumer sentiment in major economies could deteriorate more than we expect toward the end of the year due to increased trade tensions.

Key assumptions

Slower retail sales growth. We expect retail sales growth to be in the mid-single digits in China, low-single digits in Australia, and almost flat in Japan. However, we are seeing increasing risk factors regarding the intensified trade tensions, coupled with volatile stock and currency markets, and the political turmoil in Hong Kong.

Continued unfavorable funding conditions. Speculative-grade issuers in emerging markets including China still face higher funding costs, leaving less headroom for their EBITDA interest coverage ratios to absorb increasing interest expenses. Liquidity risk for rated companies is lower because of completed refinancing.

Key risks

Margin pressures. The profitability of largely offline retailers is unlikely to recover materially, given a consumer preference for price discounts amid a weakening economy, weaker consumer sentiment, and rising labor costs. In addition, competition with online retailers is mounting.

Investment needs for digitization. Retailers need to further invest in physical stores to remain competitive. In addition, the need to also invest in e-commerce infrastructure will increase their financial burden.

If the credit cycle turns. Small, less competitive retailers would face refinancing difficulties and soft consumer demand in times of a sharp downturn and worsening profitability, despite likely government stimulus.

What to look for

Consumer sentiment deterioration. Consumer confidence has become pessimistic due to a recent drop in industrial activity and weak stock markets. Retailers' ability to quickly adapt their operations and price strategy to consumer preferences and reduce costs will be key challenges.


Trade Still At The Forefront

Key Takeaways

− Credit risks from trade tensions remain an issue.

− Risks to economic and fiscal performances could increase if global economic growth slips materially.

− Lower expectations of developed market interest rates provide some cushion for sovereign credit quality.

What's changed?

Trade risks remain a concern with new tariffs announced. The threat of U.S. tariffs covering almost all Chinese imports has risen as trade talks between the world’s two biggest economies show little progress. U.S. sanctions on China’s largest mobile phone manufacturer complicates their bilateral relations, with potential disruptions for global growth and trade flows.

Lower expected interest rates in developed markets, moderating emerging market pressure. The swift change in developed market interest rate trends have seen investors searching for yields in emerging markets again. Concerns about capital outflows from emerging markets have eased somewhat as a result.

Key assumptions

Trade actions to not derail growth in major economies. Despite intensifying trade tensions, the economic slowdown in key economies in the Asia-Pacific will be moderate. Stimulus measures undertaken by governments to offset the associated pressures will not materially weaken credit metrics in most cases.

Evolving U.S.-China relations will not cause sustained and serious market disruptions. New measures from the two countries will not elevate uncertainties that could create risk aversion toward emerging economies and offset the cushion to credit quality due to the easier global monetary environment.

Key risks

Sudden capital swings possible. A sharp deterioration in international and domestic politics could still trigger investor risk aversion. Abrupt reversals in capital flows remain a risk.

Reversal of China's deleveraging. If trade talks fail and economic pressures mount, China's deleveraging policy could reverse. Sovereign credit support will likely weaken due to growing risks of financial instability, with negative implications for other sovereigns in the region.

What to look for

Geopolitical and economic risks. Higher tensions in the Middle East could sour investor sentiment and threaten energy prices. This standoff may also affect North Korea's attitude on further negotiations.

Structured Finance

Slower Growth, Subdued Consumers

Key Takeaways

− China's macro and industry issues won't materially affect securitization performance of retail assets.

− Signs of stabilization in Australian housing markets.

− Stable employment in major securitization markets will keep arrears and defaults low.

− For consumer sectors, employment remains stable in major securitization markets.

What's changed?

Interest rate cuts and housing market sentiment in Australia. Interest rate cuts and signs of stabilization in house prices have seen some improvement in sentiment for housing markets. However, this is in the face of softening economic conditions in Australia and continued slow wage growth.

Easing credit availability. Recent developments in Australia's regulatory framework including borrower debt serviceability measures point to some easing in credit availability for households.

Rising uncertainty in economic growth and trade tension in China. China recorded the lowest GDP growth for years in the second quarter, which was no surprise to the market considering the many macro and industrial challenges since 2018.The renewed trade tensions now pose a threat to the real economy.

Key assumptions

Stable employment. Ratings should be stable, given steady employment and economic (albeit slower) growth.

Key risks

Household indebtedness. While recent interest rate cuts in Australia may ease debt serviceability strains for some households, Australian households continue to have high levels of indebtedness that may see resilience tested in the event of a severe shock to the 

economy. China is facing a slightly different household debt issue- despite increasing income, debt is spiking in mortgages and consumption. China's ability to maintain stable employment and continued income growth amid many challenges will affect debt serviceability.

Japan's consumption tax increase. The tax increase in October 2019 (8% to 10%) could affect the economy.

If the credit cycle turns. If economic conditions worsen, unemployment and mortgage defaults could rise.

What to look for

China's slowdown, trade conflict. China's slowdown may worsen employment, potentially worsening loan performance. Currently, the highly diversified obligor's profile and quick accumulation of credit enhancement with fast loan paydown will underpin stable performance across transactions. The divergence among issuers in residential mortgage-backed securitization, and auto finance companies' continued penetration into lower-tier cities, however, deserve close watch for the impact on loan quality in the next 12 months.


Further Escalation In Trade Tensions Broadens Credit Impact

Key Takeaways

− New tariffs on Chinese exports of major IT products including smartphones and PCs to the U.S. will further dampen demand throughout the tech supply chain.

− Earnings could decline more significantly than we previously expected.

− Rating pressures could spread broadly beyond leveraged companies with sharper deterioration in cash flow eroding leverage buffer.

What's changed?

Escalation in trade tension. The 10% tariff on Chinese exports of major electronics products--including smartphones and PCs, implemented since Sept. 1 in two phases --will substantially weaken demand. Tariffs would raise costs and weaken margins, as companies cut inventory.

Key assumptions

Increasingly pessimistic demand. Weak smartphone demand and slowing IT investments could lead to a low single-digit percentage (on year) decline in sales of nonmemory semiconductors, and a 25%-29% decline in sales of memory chips. Demand could weaken more if the planned 15% tariff on smartphones and PCs made in China goes ahead as scheduled on Dec. 15, 2019. The trade disputes between Korea and Japan on high-tech materials are unlikely to lead to significant supply cuts to offset weakness in demand.

Continued digitalization of the economy. Transition to online shopping and services may offset the slowing consumption underpinning China's internet companies. Chinese government stimulus may support growth in consumer spending. Indian IT services companies are rolling out new technology to enhance services.

Key risks

Oversupply risk. High capex and weakening demand increase oversupply risk. Tech disputes could motivate the Chinese government to aggressively promote advanced manufacturing. Significant capacity additions amid slowing demand over the next few quarters could cap some prices of standardized components .

Technology shifts. Faster technology shifts present material risks with rising development costs, increased capital expenditure demands, and shortened product lifecycles. Demand for legacy hardware would continue to fall. Trade tariffs could force the relocation of manufacturing facilities and increase production costs.

If the credit cycle turns. Credit pressure on highly leveraged companies, such as those in China, could rise.

What to look for

Heightened credit risk. A slowing global economy and escalating trade friction could cut cash flow significantly. Current profitability and debt leverage levels may not be enough to buffer deeper-than-expected demand weakness.


Intense Competition Amid Ongoing Large Investments

Key Takeaways

− Despite steady regional GDP growth and rising mobile data consumption, we see gradually increasing downward pressure on credit quality due to stiff competition and ongoing investment needs. 

− Competition remains intense in India, Australia, Korea, Singapore, and Malaysia, with pricing becoming more aggressive. 

− Capex will increase modestly, amid the arrival of advanced networks such as 5G.

What's changed?

Intense competition, 5G capex.  Competition remains intense with deeper cuts in wireless tariff pricing in India, Malaysia, Australia, Singapore, Japan, and Taiwan. Large capital investments are likely for advanced networks such as 5G.

Key assumptions

Growing mobile data usage. We expect mobile data usage to continue to rise. This, combined with steady regional GDP growth, should support gradual revenue increase for Asia-Pacific telecom operators. However, we assume ongoing modest pressure on profitability due to intense competition and aggressive pricing.

M&A to continue. We expect ongoing M&A activities in the region given faster media and telecom convergence and the rise of 5G. In Korea, we expect M&A in the pay-TV industry, as indicated by recent cable TV operator acquisitions announced by SK Telecom and LG Uplus.

Key risks

Aggressive pricing and new entrants. Major players in India, Malaysia, Singapore, and Philippines are adopting aggressive pricing strategies. We also expect new telecom operators in Singapore, Japan, and Australia to intensify wireless market competition.

Pressure from NBN in Australia. The growing presence of Australia's National Broadband Network amid intense competition has pressured local telecom operators' credit quality such as Telstra and Singtel Optus.

If the credit cycle turns. Should economic conditions worsen, consumer demand growth could be curtailed to some extent. However, the credit impact should be limited given the countercyclical nature of the industry.

What to look for

5G rollout. Commercial 5G wireless networks will roll out in 2019 or 2020, and Korean operators launched commercial 5G in April 2019. Substantial investments in Korea, Japan, China, and Australia may be required.

Transportation Cyclical

Higher Risk Of Lower Trade Volumes

Key Takeaways

− Trade and geopolitical risks are likely to weigh on passenger and freight volume growth.

− Oil price gains in 2019 have now reversed.

− Lower trade volumes, a stronger U.S. dollar, or higher oil prices could undermine transportation companies in the region.

What's changed?

Trade and geopolitical risks. The trade confrontation between the U.S. and China, softening industrial production, a stronger U.S. dollar, and recent events in Hong Kong are likely to weigh on regional passenger and freight volume growth.

Volatile oil prices. The rebound in oil prices proved short-lived with prices losing their gains in 2019.

Key assumptions

Oil prices to soften. We assume oil prices will stay at current levels in 2019 and 2020 (Brent crude average US$60/barrel and West Texas Intermediate crude at US$55/barrel). That said, looming regulation from the International Maritime Organization restricting the amount of sulfur in fuel oil used on ships could have a knock-on effect for airlines.

Fundamentals remain sound. We expect recent air traffic to generally remain healthy, albeit with growth at more moderate levels. For shipping, soft new vessel deliveries are likely to support rates. Conditions remain healthy for equipment lessors.

Key risks

Slowing growth or rising trade tensions. Containerized freight volumes are sensitive to economic conditions. We also note that China is the largest importer of certain dry bulk commodities.

Higher U.S. dollar. Currency weakness versus the U.S. dollar makes it costlier for non-U.S. transportation companies to pay for oil, acquire dollar-denominated equipment, and service dollar-denominated leases or secure debt to finance equipment.

If the credit cycle turns. Higher debt costs or reduced access to capital could pressure capital-intensive transportation companies. We note that debt for the sector is largely on fixed rates.

What to look for

Slowdown in trade volumes. A slowdown of trade volumes would directly harm the global shipping industry. We will also monitor how the transportation industry responds to fuel price and currency movements.

Transportation Infrastructure

Global Disputes And Funding Mix Are Key Risks

Key Takeaways

− Rising external risk from continued U.S.-China trade tensions and volatile currencies are key risks.

− Existing infrastructure deficit and growth will support demand.

− Regulations remain stable and investor appetite continues to be strong, although funding and market conditions could sour with increasing geopolitical and macroeconomic risks.

What's changed?

Continued global disputes. The U.S.-China trade dispute is escalating with no resolution in sight. Geopolitical incidents in Middle East sea routes are escalating. Tariffs could have a greater impact on export-oriented ports in China and Southeast Asia.

Key assumptions

Capex growth. High passenger growth will lift airport capex in developing Asia (India, Vietnam), and Australia and New Zealand. Toll road investment remains elevated in Indonesia, while India tries to revive private sector interest. China continues to spur investment in large infra projects to shore up the economy while its Belt and Road initiative supports other projects. Metro and bullet train projects across Asia are driving rail investments.

Stable regulation, strong appetite. Regulations should remain supportive and investor appetite strong, sustaining growth in capex and M&A valuations. Investments remain strong, primarily for roads and airports.

Key risks

Trade disputes. The trade dispute is escalating; while broader auto tariffs with EU and other countries are still to be fully resolved. We haven't seen any direct impact from the trade dispute yet, but China's slowdown remains a key risk. The impact of rerouting supply chains and on economic growth remain uncertain.

Tighter Chinese regulations. Despite the infrastructure stimulus to stabilize China's economy, a tighter grip over local governments' off-balance sheet borrowings and lack of financially viable projects continue to contain infrastructure growth. Near-term refinancing risk of local government financing vehicles is largely manageable, but weaker borrowers are still vulnerable to changing policy and funding conditions.

If the credit cycle turns.  A challenging funding environment may pause or reduce some infrastructure investment while putting pressure on projects with limited financial cushion.

What to look for

Huge infrastructure plans. Indonesia, India, Philippines, as well as China, have significant infrastructure development plans. The feasibility of some large government projects is uncertain. Political continuity in India and Indonesia is a positive but detailed infrastructure investment funding plans are still being finalized.


Renewables Continue To Grow

Key Takeaways

− Stable demand conditions continue across the region.

− Clean energy policies remain the focus of most governments to reduce emissions and bring them on a competitive footing to coal plants and slowly wean them from subsidies.

− Utilities have modest rating headroom; however, liquidity levels are a risk amid high capex and, in some cases, delays in government subsidy payments.

What's changed?

Refining renewable landscape. The desire to lower costs and emissions keeps the focus firmly on renewables, triggering more policy changes. The goal is to make renewables more competitive with coal and to wean renewables-focused projects off subsidies, such as has been done in China. M&A has slowed given subdued returns, local opportunities for organic growth, and a renewed focus on liquidity. However, in India, industry churn involving the sale of asset portfolios, or larger majors acquiring operational projects, will result in some acquisitions. In China, delayed subsidies and high leverage have weighed on the sale of renewables assets by private developers, to state-owned enterprises.

Key assumptions

Mixed capex, funding. China's capex will remain high on grid investment and renewables (especially wind) but low on coal power. Capex is likely to remain high in India and Indonesia, benign in Australia, and moderate elsewhere. An appropriate mix of debt and equity should reduce liquidity stress.

Key risks

Regulatory change. Given evolving policies, the pace of change and implementation is key. Australian utilities face earnings pressure due to a retail price cap and more market scrutiny. China continues to liberalize its power market and reduce renewable subsidies. Regulatory stability is likely in South and Southeast Asia.

Market access and liquidity. Subdued economic conditions in Asia-Pacific and U.S.-China policies could dampen investor sentiment. Liquidity management and approach to

refinancing remain adequate but pockets of weakness remain, such as Chinese solar power developers saddled with delayed subsidies.  China's easing financing conditions to bolster the economy would mitigate this risk.  Avenues for funding thermal power projects are getting more limited with most OECD and international banks focusing on sustainable financing.

What to look for in

New projects, funding. Opportunities in local markets and some consolidation in renewables will offer avenues for M&A. Leverage is high among Chinese utilities and in parts of Asia due to debt-funded capex for new capacity. While some rating headroom remains in the sector, aggressive growth can bring risks.