China has long shown its willingness for stimulus in times of economic stress. However, in recent years the country has seem diminishing returns on such macro and financial levers. Stimulus programs can also conflict with reform goals to rein in government debt and economic leverage. Moreover, the country's zero-COVID policy has in some cases delayed stimulus aimed at offsetting economic weakness in other areas, such as waning property investments.

These knotty issues were discussed at a webinar S&P Global Ratings held on Oct. 11, 2022. This is one of three FAQs summarizing key topics addressed at the event, including via direct questions from participants. Please also see two related reports, covering other topics addressed at the wide-ranging event: "A Slower China: What Are The Macro Implications?" and "A Slower China: Where Are The Pockets Of Risk?".

A reply of the webinar, titled, "A Slower China: Cross-Sector Credit Updates," is available here.

Economic Stimulus--Tough Economic Situation And Stresses On Local Governments Put A Lid On Spending Rebound

Will China focus on infrastructure development in 2023 to stimulate the economy?

This depends on COVID policy. At one level, harsh restrictions hurt economic activity, prompting the need for stimulus projects to offset the drags. On the other hand, lockdowns also interrupt or prevent planned stimulus projects from getting underway. Infrastructure projects generally take anywhere between two and 10 years to complete, depending on scale. Thus, if an investment boost were to be followed by a financing cut-off the next year, construction activities would be hampered and result in unfinished projects. In our view, policymakers prefer a more consistent policy direction for any stimulus to be effective.

That said, next year will not likely bring a pronounced rebound in infrastructure spending (e.g., similar to 2016-2017, with year-on-year growth of more than 15%). Although the government has reverted to infrastructure stimulus amid this year's tough economic situation, authorities are also cognizant of stresses on local governments, as well as reform goals to reduce off-budget financing or over-leveraging to fund projects with insufficient demand or benefits. Local governments are already very highly leveraged. An infrastructure push is not going to result in the kind of boom or rebound seen in the past.

Has the stimulus released so far this year been effective in boosting China's infrastructure spending?

Infrastructure investment is rebounding. In term of numbers, infrastructure growth (excluding power and others) was about 8% for the first eight months. This compares with below 5% in 2018-2019, and even lower growth through 2020-2021. However, the trajectory differentiates among the sub-sectors. For power, heating, gas, water production and supply, we see 15% year-on-year expansion in terms of fixed asset investment. Other high-growth areas include water conservancy and public facilities. On the other hand, road and rail transport segments continue to see limited forward momentum, or even declines.

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Is the stimulus being directed to areas where the funding is really needed? Or are we seeing mismatches or misallocations?

At this moment, it seems local governments--which carry out the vast majority of the country's stimulus spending--are focusing on projects that can get underway quickly, thus boosting construction activity. However, such decisions could come under question if these projects do not generate cash flow over time. In recent years, the central government has guided local governments to focus on more productive investments. There is a strong push for projects that will bring the greatest benefits, in terms of development goals or project-level returns.

Funding for such spending is also evolving to become more transparent and hence boost central-level monitoring of local government spending. Tier-one local governments are now able to directly issue "special-purpose bonds" for infrastructure spending, rather than relying on indirect funding via their incorporated financing arms. The process requires transparent public disclosure about the investment returns and the repayment timeframe for new project financed by such bonds.

While periods of economic stress may lead to some wasteful spending to boost activity, we think that the longer-term trajectory is toward more disciplined project selection and financing structures. And more direct debt issuance is key to this reform. That said, we have noted that infrastructure spending has not kept pace with issuance of the special-purpose bonds, a sign that some of the funds may be redirected or bureaucracy is slowing the dispersal to projects.

Is China offering direct stimulus to households, as seen during the start of the pandemic in developed economies?

No. A very little part of China's stimulus this year has been geared toward households. The recent packages have returned to the old recipe of investment-driven credit, finance, and infrastructure investment. So it has derailed the goal of economic rebalancing towards a larger role for consumption.

That said, we do think the investment stimulus is more controlled, and more targeted to where funding is needed. For example, the "three red lines" policy remains in place to promote deleveraging in the property sector. At the same time, increased funding for social housing will offset some of the slowdown in construction-related activity.

How does S&P Global Ratings reflect potential future stresses on the credit quality of infrastructure SOEs?

Our rated infrastructure SOE issuers mainly include power and utilities, transportation infrastructure entities and local government financing vehicles (LGFVs).

For power and utilities issuers, business resilience is stronger compared with other sectors, even in a downcycle. However, they do still face insufficient cost pass-throughs, especially for independent power producers (IPPs). Periods of slow pass-through are more likely when state planners are seeking to protect consumers or the broader economy from volatility or deterioration.

With these obligations, however, the IPPs also enjoy certain benefits, such as strong support by the financing market in China. As to the outlooks over the next two years, we think most of the IPPs have sufficient credit buffers and will see improvements in operating conditions. The outlook is similar for transportation infrastructure issuers; they benefit from strong financing capabilities and business resilience.

Most of the rated LGFVs are relatively important platforms under higher-tiered local governments. They benefit from substantial ratings' uplift from government support due to the roles and importance in their respective regions, despite having weak financial metrics and stand-alone credit profiles (mostly 'b' category). A benign financing environment since 2021 has widened funding access and made for favorable costs, underpinning stable outlooks.

Stress Test --SOEs Are Facing A Debt Trap

Why does S&P Global Ratings say that SOEs are facing a "debt trap"?

Because most SOEs are highly leveraged, more so than headline averages show. In our recent study of 6,000-plus Chinese companies, we found that SOEs generate about 60% of corporate revenues. However, when we drilled down further into the SOEs (segregating the top 10% by revenue versus the remaining 90%), we observed that the bottom 90% by revenue carried 45% of sample debt. So the end result is the debt to EBITDA is about 18x for the bottom deciles, which is massive compared with 3x-4x for rest of the sample. With the economic slowdown, it's going to be a struggle for them to repay the debt principal. And for that reason, we say they are in a debt trap.

Our sample was mainly for unrated companies, where about one-third were SOEs and the remaining two-thirds were private-owned enterprises, or POEs (see "Global Debt Leverage: China's SOEs Are Stuck In A Debt Trap ," Sept. 20, 2022).

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Energy Transition--Long Way To Go And Coping With Climate Change

Has the slowdown in China derailed China's energy transition? Is it happening or not?

We think China continues to progress toward its ambitious energy-transition targets. Neither recent economic headwinds, nor the energy security concerns raised by the Ukraine war and other geopolitical events, will derail the shift.

China plans to make further heavy investments into its renewable energy generation and grid assets to improve efficiency and flexibility of its power system. However, breaking the reliance on fossil fuels, including coal, cannot happen in just a few years. Energy security risk will remain a counterforce until China develops the technology to cope with intermittency of renewables. We saw this in the power crunch that hit some southwestern provinces this past summer due to drought. Thus investments are still also pouring into fossil-fuel generated power; in our view, these investments are mainly to replace old equipment or to ensure capacity at times of peak demand.

China suffered extreme weather events this year, from massive floods to a very long drought. Has this changed the landscape for Chinese insurers and the demand for protection?

Climate change is high on the policymakers' agenda. We see increasing cooperation between Chinese authorities and industry players (insurers and reinsurers). One such example is the introduction of catastrophe reinsurance pool. After a major quake, China's residential earthquake insurance pool was established in 2015.

However, climate change is a double-edged sword for Chinese insurers. It brings increased claims and complicates risk-modelling. On the other hand, it may also boost household and corporate protection demand in China's underpenetrated property and casualty insurance market.

In the case of agricultural insurance, increased government subsidies has also propelled growth. For the first eight months of 2022, this business line grew by 28.5%.

That said, China's protection gaps are still wider than the global average. Beyond climate change concerns, China's diverse and expansive landscape is still urbanizing. This also calls for more frequent updates to the catastrophe models that insurers are relying for effective risk assessment.

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Editor: Cathy Holcombe

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