China's zero-COVID policy and weak property market are hurting consumption and business confidence. Slower growth in turn has implications for the health of local and sovereign governments, banks, and various corporate sectors. On Oct. 11, 2022, S&P Global Ratings held a webinar to provide investors and others with its latest view on the country's outlook.

In this article, we summarize some of the key topics discussed 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: Is Stimulus Working And Who's Paying For It?" and "A Slower China: Where Are The Pockets Of Risk?".

A replay of the webinar, titled, "A Slower China: Cross-Sector Credit Updates," is available here. Registration will also provide slides and other related materials.

Macroeconomics--Growth Likely To Remain Subdued

Will China relax its COVID stance anytime soon? And when the pandemic restrictions do ease, will the country resume its leading growth rate among emerging markets?

China's reopening is going to take some time. After the March 2023 National People's Congress, we think there could be a more meaningful lifting of the restrictions and change in the overall stance in the second quarter of 2023. However, the overall process will likely be quite gradual.

The sentiment on China's growth trajectory is very weak, reflecting the strict COVID stance and the property sector downturn. However, once China reopens, we anticipate growth momentum could pick up, outpacing most other emerging markets (barring a few like India). We believe the country's trend-rate growth will be around 4.5%-5% in the coming years, and down to below 4% by 2030.

With real estate investments slowing, have state-owned enterprises or other stakeholders redirected spending toward other areas?

China has three main areas of investments: property, infrastructure, and corporate investment. This year, the decline in property investment has been partly offset by an increase in infrastructure investment. Overall investment spending is on the wane.

Even though China is a major energy importer, its current account balance has not deteriorated this year. This stems from its strong export performance relative to a weak import performance. The country's financial surplus has improved vis-à-vis the rest of the world (national saving minus investment), even though its terms of trade have deteriorated.

How hard will the U.S. Federal Reserve's continuous rate hikes hit China's economy? Could the country go into a deep recession?

When U.S. interest rates go up, global demand slows down. This has an impact on China's real economy via slower export growth. Concurrently, the risks of capital outflows increase as higher U.S. interest rates put pressure on foreign exchange (forex) markets. The People's Bank of China and other policymakers in the country have acknowledged that higher global interest rates are indeed constraining their leeway to lower interest rates, forcing them to take smaller steps.

Even though we expect China's economy to expand by only 2.7% for 2022, we are not calling it a recession. In China, policymakers continue to play a strong role. We think that negative growth is quite unlikely, as policymakers do have all the tools and leverage to prevent that from happening.

Sovereign and International Public Finance--The Pain That Comes With Structural Reforms

China's focus on structural reforms has put some sectors under stress. Are policymakers inclined to reverse or contain such sector stresses, in order to support growth?

In our view, the structural reforms are not going away. The pace of reforms may slow, at times, if economic stability is threatened. Examples from the past year include some flexibility in property firms' use of escrow accounts, or internet companies being given more time to widen social security benefits to ad hoc employees (e.g., delivery drivers). This underpins the delicate balancing act between reform and economic development and growth. Ultimately, however, policymakers remain focused on derisking the country's credit-dependent growth model. With structural reforms to remain a priority, constraints across important sectors will likely persist.

Could China continue to revert to a more centralized economy and if so, how would that affect the sovereign rating?

We believe policymakers understand the importance of decentralization for long-term growth. While restrictions have tightened on information technology, real estate, and education, we consider these sectors to have politically strategic and socially impactful considerations. The government has been easing some restrictions and promoting other sectors, such as small and midsized enterprises (SMEs). In addition, the country's "little giants" initiative points to efforts to promote economic growth, albeit more steadily. Should these drags and supports balance out, the impact on sovereign ratings will be relatively neutral.

Local and regional governments (LRGs) face reduced land sales, slower GDP growth, and disruptions due to China's COVID policy. Can they take mitigating actions to offset the fiscal drain?

For most, the answer is no. We anticipate most local governments will stick to expansionary fiscal policies through 2022. Revenues are declining due in part to lower contributions from land sales or property-related transaction taxes. As such, most will keep borrowing to fund local stimulus. We forecast the deficit of China's LRG sector will reach 20% of their total revenue for this year: a record high. However, this will likely be transitory as we believe fiscal consolidation remains a long-term resolution.

Are all LRGs in the same boat?

No. Some of the highly indebted cities/regions will not be able to borrow much more, due to limitations set by Beijing. That means they will run down their cash and liquidity resources to support local growth, adding to financial fragility. Those unable to borrow or lacking immediate sources will feel most of the brunt of the economic slowdown.

The pain points faced by local and region governments differ. In the case of the real estate slowdown, the fiscal impact will weigh on high-income cities/regions while low-income cities/regions will lose a key growth driver. This is because the high-income cities and regions tend to rely heavily on land sales and property transaction taxes for their revenues and such dependency exposes them to the risk of high fiscal deficits.

Meanwhile, a lot of low-income cities depend heavily on property investment for GDP growth. The property slowdown constrains their ability to use investments to promote local growth. We believe that this factor will be a driver of the cities' slowdown in terms of fiscal or local development.

How important is state ownership in our ratings universe?

It remains important because the majority of companies we rate in China have some or total state ownership. Through ownership control, governments can direct SOEs and local-government financing arms to play important roles in facilitating development in China, and thus, in our view, benefit from the likelihood of extraordinary government support. This translates into upward notching above the stand-alone rating profile for such companies (see as background, "China Credit Spotlight: Analyzing China's State-Owned Enterprises," published on RatingsDirect on Sept. 12, 2012).

However, not all SOEs get such uplift. We only provide an uplift if we see a tight linkage of the rated company with the government, including a framework of allowing sufficient resources of support (see chart 1). In light of reforms to increase corporate efficiency and deleverage, extraordinary government support will over time get more selective, in our view.

Our view of increased selectivity also underlines the fiscal strain such local governments face, most of which are highly indebted. In terms of the resources or capacity to support their SOEs, these governments need to prioritize resource allocation. If a corporate arm is critically important or very close to the government, such entities will likely keep the same level of government support. While we expect government support will get more selective over time, in line with reforms, we have lowered our assessment on the likelihood of government support for only a small portion of our rated universe.

Chart 1

Editor: Cathy Holcombe

Digital design: Evy Cheung

Related Research

• Sector Roundup Asia-Pacific Q4 2022: More Pain Points As Growth Slows, Sept. 28, 2022
• Credit Conditions: Asia-Pacific Q4 2022: Brakes On Growth, Pain Down The Road , Sept. 27, 2022
• Economic Research: Economic Outlook Asia-Pacific Q4 2022: Dealing With Higher Rates, Sept. 26, 2022
• China's Big-Four Asset Management Companies Downgraded On Deteriorating Prospects; Outlooks Stable , Sept. 21, 2022
• China Trades Immediate Economic Growth For Uncertain Benefits, Sept. 20, 2022
• China's Zero-COVID Stance Poses A Bigger Threat To Firms Than Inflation , Sept. 20, 2022
• Global Debt Leverage: China's SOEs Are Stuck In A Debt Trap , Sept. 20, 2022
• Power Cut Flags Risk Of Hydropower For China's Chalco And Hongqiao , Sept. 20, 2022
• Country Garden Downgraded To 'BB' From 'BB+' On Declining Sales; Outlook Negative , Sept. 19, 2022
• Only China's Government Can Revive Property Confidence , Sept. 15, 2022
• Asia-Pacific Reinsurers And Governments Fortify Natural Disaster Defenses , Sept. 13, 2022
• Asia-Pacific's Nonbanks Brace For Funding Squeeze , Sept. 5, 2022
• A Primer On China's Consumer Loan Asset-Backed Securities Market , Sept. 2, 2022
• China's Summer Struggle: Drought, Food Inflation, And Shortages , Aug. 31, 2022
• Credit FAQ: More Asia-Pacific Angels Risk Slipping Into Speculative Grade , Aug. 30, 2022