Overview

• Policy changes have helped to rein in credit growth and reduce the reliance of economic growth on public investment. If these trends continue, risks to China's economic and financial stability could moderate.
• China's economic growth is likely to slow further in the next few years. The economy is also likely to face elevated uncertainties owing to U.S.-China tensions and ongoing efforts to restructure the economy and reduce financial risks.
• We affirm our 'A+' long-term and 'A-1' short-term sovereign credit ratings on China.
• The stable outlook reflects our view that China will maintain above-average headline GDP growth and improve its fiscal performance over the next three to four years.

Rating Action

On Sept. 30, 2019, S&P Global Ratings affirmed its unsolicited 'A+' long-term and 'A-1' short-term sovereign credit ratings on China. The outlook on the long-term ratings is stable.

Outlook

The stable outlook reflects our view that China will maintain above-average headline GDP growth and see improved fiscal performance over the next three to four years. We expect per capita real GDP growth to stay above 5% annually, even as public investment growth slows further. In addition, we anticipate the stricter implementation of restrictions on the off-budget borrowings of subnational government to lead to a declining trend in fiscal deficits, as measured by changes in net general government debt in terms of GDP.

We may raise our ratings on China if credit growth slows further and is sustained below nominal income growth even as structural reforms help to maintain healthy real GDP growth. Fiscal support should also improve if general government deficits are lower than we currently expect. In this scenario, we believe risks to financial stability and medium-term growth prospects will lessen.

A downgrade could ensue if we see a higher likelihood that China will ease its efforts to stem rising financial risk and allow higher credit growth to support economic expansion in an unsustainable manner. We expect such a trend would weaken the Chinese economy's resilience to shocks, limit the government's policy options, and increase the likelihood of a sharper decline in the trend GDP growth rate.

Rationale

The ratings on China reflect our view of the government's reform agenda, growth prospects, and strong external metrics. We weigh these strengths against certain credit factors that are weaker than what is typical for similarly rated peers. For example, China has lower average income, less transparency, and a more restricted flow of information.

Institutional and economic profile: Reforms to budgetary framework and financial sector in progress

• China's policymaking has helped it to maintain consistently strong economic performances since the late 1970s.
• We project China's per capita GDP to rise to nearly US$12,000 by 2022, from a projected US$10,000 for 2019.
• We expect real GDP per capita growth to remain above 5% annually in the next three years. We believe the current growth trajectory is less driven by credit disbursed by financial institutions than in previous years.

A number of factors have come together to put pressure on Chinese economic growth in the near future. These include the government's efforts to rein in financial risks, the weakening global economic growth and uncertainties associated with the bilateral tensions with the U.S. This has led to weaker expectations of Chinese economic growth for the next few years. Nevertheless, we continue to see real GDP growth of above 5% annually for the next three to four years.

The sustainability of superior economic performance, compared to peers at similar income levels, is likely to require further structural reforms in China. We do not expect U.S.-Chinese relations to normalize in the foreseeable future. This likely means that Chinese exports and manufacturing sector investment could see little growth over the next few years. U.S. restrictions on technology transfers to China could also hinder productivity improvements. In this environment, China is more likely to maintain strong economic growth if the reform momentum picks up.

The Chinese government appears to be taking new steps to improve economic efficiency and reduce financial risks. Policy measures to stabilize growth announced or implemented this year have differed from previous rounds of economic stimulus. While infrastructure spending remains a means of stimulating demand, the government has continued to rein in off-budget financing at local governments. It has also made more effort to support smaller enterprises that have recently come under greater pressure.

The government appears willing to accept the somewhat weaker economic growth that comes with these less direct support measures. We believe this tolerance for slightly slower growth is the reason broad credit growth has not picked up strongly despite the weaker growth prospects. We no longer believe strong credit growth will keep economic performance unsustainably strong. If stable or weakening credit growth persists, it could reduce the risk of financial instability that could affect the wider economy.

In the past year or so, the government has introduced new initiatives to experiment with further liberalization measures and greater openness to international investment. It recently ended ownership limits on foreign investors in the financial sector. Controls on foreign capital inflows to its financial markets were eased. The Chinese government also plans to liberalize economic laws and regulations in the city of Shenzhen, next to Hong Kong, and to expand the Shanghai free trade zone.

China's ability to adapt and change in response to the environment has helped the country to maintain consistently strong economic performances since the late 1970s. However, coordination issues between the ministries and the State Council sometimes lead to unpredictable and abrupt policy implementation. The authorities also have yet to develop an effective communication channel with the market to convey policy intent, heightening financial volatility at times. Moreover, China does not benefit from the checks and balances usually emanating from the free flow of information. These characteristics can lead to the misallocation of resources and may foster discontent over time.

Flexibility and performance profile: Capital account liberalization could lead to further growth of foreign holdings of Chinese financial assets

• We expect liquid financial assets held by the public and financial sectors to exceed total external debt by almost 70% of current account receipts (CAR) at the end of 2019. At the same time, we estimate China's total external assets will exceed its external liabilities by 70%-75% of its CAR.
• For 2019-2022, we project net general government debt to increase annually by 3%-4% of GDP. We project that net general government debt will fall below 52% of GDP in the period to 2022, and interest cost to government revenue will remain below 5% throughout the forecast horizon.
• In our view, China's monetary policy is largely credible and effective. We believe the liberalization of interest rates at banks in recent years is an important reform that could further improve monetary policy transmission.

China's external profile remains a key credit strength, reflecting its position as a large external creditor and increasing international use of the renminbi. We expect financial assets held by the public and financial sectors to be close to 70% of CAR at the end of 2019. At the same time, we estimate that China's total external assets will exceed its external liabilities by more than 60% of its CAR. Its external liquidity position is equally robust. We anticipate China's current account will be nearly balanced in 2019-2021. Annual gross external financing needs in 2019-2022 should total 70%-75% of CAR plus usable reserves.

We believe the increasing global use of the renminbi bolsters China's external financial resilience. According to the Bank for International Settlements' (BIS) "Triennial Central Bank Survey," published in 2016, the renminbi was traded in 4% of foreign exchange transactions globally. We therefore assess the renminbi as an actively traded currency.

Demand for renminbi-denominated assets has increased in recent years. We expect the share of renminbi-denominated official reserves to rise. If the renminbi achieves reserve currency status (which we define as more than 3% of aggregated allocated international foreign exchange reserves), it could strengthen external and monetary support for the sovereign ratings. Although the People's Bank of China (the central bank) does not operate a fully floating foreign exchange regime, it has allowed greater flexibility in the nominal exchange rate over the past decade.

Even as economic growth slows, China continues to implement its ambitious fiscal reform to improve fiscal transparency, budgetary planning and execution, and subnational debt management. Despite the significant increase in subnational government bond issuances in 2019, infrastructure investment growth has remained low so far in the year. This could indicate stringent enforcement of measures to curb off-budget borrowing by local governments. Over time, we expect these reforms to help improve fiscal stability and efficiency of public spending.

In 2019-2022, we expect the Chinese government to keep the reported general government deficit close to, or below, 3% of GDP. However, off-balance-sheet borrowing could continue during this period. This reflects both the financing needs of public works started previously as well as some new projects that the central government is willing to authorize to support growth.

The use of off-balance sheet capital spending by local governments complicates the estimation of general government debt in China. In our view, the official disclosure of this indicator underestimates the fiscal debt burden as debts incurred by local government financing vehicles (LGFVs) for public investment are not included. For this reason, we have added our estimates of such debts to the official general government debt. We have also included the debts of the recently restructured China State Railway Group Co. Ltd. in general government debt. The company was previously the Ministry of Rail but was incorporated as a special industrial enterprise. Bonds issued by the company are held on the books of Chinese banks at a lower capital charge compared with other corporate debt. We have also added some debts related to the establishment of the national asset management companies more than a decade ago.

We offset these debts to compute net general government debt with fiscal deposits held by the government, net assets of the China Investment Corp., net assets of the National Council of Social Security Funds, and our estimate of liquid assets held by LGFVs. Using this method, we project net general government debt will fall below 52% of GDP in the period to 2022 and interest cost to revenue will remain below 5% throughout the forecast horizon. These forecasts in turn follow from our assumptions regarding real growth and ample domestic liquidity keeping financing costs low for the government. Using the estimates above, we project the increase in net general government debt in each of these years at 3%-4% of GDP.

Based on our assessment of China's Banking Industry Country Risk at '6' and the banking sector's balance sheet size of just above 200% of GDP, we see limited contingent liabilities coming from the financial system. In computing the gross assets of the banking sector, we reduce the total amount by the sectors' claim on the government. We also see limited sovereign exposure to other sources of contingent liability.

We believe China's monetary policy is largely credible and effective, as demonstrated by its record of low inflation and its pursuit of financial sector reform. Consumer price inflation is likely to remain below 3% annually over 2019-2022. Although the central government--through the State Council--has the final say in setting interest rates, we believe the central bank has significant operational independence, especially regarding open-market operations. These operations affect the economy through a largely responsive interbank market and a sizable and fast-expanding domestic bond market. The liberalization of commercial interest rates at banks in recent years is an important reform that could further improve monetary transmission in China.

Key Statistics

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Ratings Score Snapshot

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Related Criteria

• Criteria | Governments | Sovereigns: Sovereign Rating Methodology, Dec. 18, 2017
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009
• General Criteria: Methodology: Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009

Related Research

• Banking Industry Country Risk Assessment Update: September 2019
• Sovereign Ratings List, Sept. 4, 2019
• Sovereign Ratings History, Sept. 4, 2019
• Sovereign Ratings Score Snapshot, Sept. 2, 2019
• Credit FAQ: Hong Kong Government Ratings Have Buffer To Absorb Impact Of Protests, Aug. 30, 2019
• China Credit Spotlight: The Trade War Is A Distraction, Aug. 27, 2019
• Asia-Pacific Sovereign Rating Trends Midyear 2019, July 26, 2019
• Global Sovereign Rating Trends: Midyear 2019, July 26, 2019
• Sovereign Risk Indicators, July 12, 2019; a free interactive version is available at http://www.spratings.com/sri
• Default, Transition, and Recovery: 2018 Annual Sovereign Default And Rating Transition Study, March 16, 2019

In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision.

After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts.

The committee's assessment of the key rating factors is reflected in the Ratings Score Snapshot above.

The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria And Research').

Ratings List