Bangkok--11 Oct--Moody's
The first sentence of the Previous Rating Action and Methodology section is corrected to read, "The last rating action on the People's Republic of China was taken on 9 November 2009, when Moody's changed the outlook on the government's A1 ratings to positive from stable.".
Moody's Investors Service has today placed on review for possible upgrade the Chinese government's bond rating of A1.
The main reasons for the decision are:
1. The resilient performance of the Chinese economy following the onset of the global financial crisis, and expectations of continued strong growth over the medium term.
2. The government's quick, determined and effective stimulus program, the unwinding of which has begun.
3. The lack of erosion in central government financial credit fundamentals, and the likely containment and effective management of prospective, contingent losses arising from the extraordinary credit expansion in 2009.
The rating review affects the government's A1 foreign and local currency bond ratings, China's A1 country ceilings for foreign and local currency bank deposits, and its A1 ceilings for foreign and local currency bonds.
Moody's intends to conclude its review within a three-month period. These ceilings act as a cap on ratings that can be assigned to the domestic or foreign currency obligations of other entities domiciled in the country. The short-term foreign currency rating remains at P-1 and is therefore unaffected.
RATIONALE FOR REVIEW FOR POSSIBLE UPGRADE
Moody's changed the outlook on China's ratings outlook to positive from stable in November 2009 in recognition of the country's resilient and strong macroeconomic performance in the wake of the turbulence from the global financial crisis.
"We also took the view that the government's very strong credit fundamentals would likely restart an improving trend as the Chinese economy emerges and stabilizes from the effects of the global recession.
In addition, we premised our action on the ability of the Chinese authorities to protect systemic stability from the underlying threats arising from the extraordinary credit expansion evident in 2009," says
Tom Byrne, a Moody's Senior Vice President.
"The record of the past year demonstrates that China's policy response to the 2008 crisis has been effective. Real GDP growth initially rebounded rapidly in response to the stimulus measures, and has recently moderated to a sustainable annual rate of around 8-9 percent," says Byrne.
The gradual re-balancing of the Chinese economy now underway will also help ensure long-run sustainability. Since last year, private consumption has been rising as fast as, or even faster than nominal GDP growth.
We expect that trend to intensify with a more rapid rise in wages in the future. Moreover, as the government strengthens the country's social safety net the need for pre-cautionary savings would be reduced.
At the same time, inflation remains moderate, with only food prices exhibiting upward pressures. Unlike some advanced countries, China does not have the challenge of dealing with deflationary pressures arising from strained private-sector balance sheets and high government debt.
The orchestration of an extraordinary economic stimulus program has so far only modestly affected government finances. With a policy intention to contain the budget deficit to 3% of GDP this year, and with the likelihood that direct government debt will remain below 20% of GDP, the government will likely be able to finance its deficits readily and at low cost from the country's large pool of national savings.
China's exceptionally strong external position and the government's negligible reliance on external financing have greatly lowered the country's vulnerability to global financial market volatility, the threat of capital flow reversals driven by deleveraging, and sudden shifts in credit or market confidence. This situation represents an important credit strength, and which has enabled China to withstand the pressures that have damaged the credit fundamentals of more exposed countries, not only during the global financial crisis, but also during the Asian financial crisis more than a decade ago.
With net international financial assets equal to about 50% of GDP -- bolstered by almost $2.5 trillion in official foreign exchange holdings -- only a handful of highly rated advanced industrial economies, such as Norway, Switzerland, Japan, Hong Kong and Singapore, have a stronger international investment position than China.
RISKS TO THE RATING AND ECONOMIC OUTLOOK
Although Moody's has concerns over the intrinsic, stand-alone strength of China's banking system, we nonetheless recognize that its largest banks have not been materially damaged by the global crisis. Therefore, the dominant banks in the system will not likely pose any sizable contingent liability risk to the government's balance sheet. Moody's further expects that future credit losses -- arising from the
surge in lending in 2009, from exposure to the property market, from risky loans to local government financing vehicles, and from off-balance sheet operations in the "shadow" banking system -- will be mostly absorbed by the banks themselves, either from capital, or from future earnings.
However, transparency is lacking on the extent of such potential losses. While uncertainty persists about the size and soundness of off-balance sheet local government financing operations in particular, we also believe that the central government has ample fiscal headroom to absorb future losses.
Externals risks pose the most significant risks. A relapse into recession in the US and EU would adversely affect China's export growth, still a key driver of economic growth.
In addition, long-simmering trade frictions with the US may be rising to a boil as legislation is advancing in the US Congress that would allow for the imposition of countervailing duties on exports from countries with a "fundamentally undervalued" currency. A severe deterioration in the bilateral China-US trade relationship would also have adverse effects on the tenuous global economic recovery, elevating the risks of a double-dip global recession.
CREDIT TRIGGERS FOR A POSSIBLE UPGRADE
These would involve:
1. Greater assurance that local government off-budget financial operations have been contained, and are manageable without imposing a burden on the central government's balance sheet and its financing costs.
2. Continued likelihood of success in macro-prudential regulation of the banking sector to ensure continued systemic stability without the need for extraordinary support from the government.
PREVIOUS RATING ACTION & METHODOLOGY
The last rating action on the People's Republic of China was taken on 9 November 2009, when Moody's changed the outlook on the government's A1 ratings to positive from stable.
The principal methodology used in rating the government of China is "Moody's Sovereign Bond Methodology", which was published in 2008 and can be found at www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that
may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody's website.
Singapore
Thomas J. Byrne
Senior Vice President - Regional Credit Officer
Sovereign Risk Group
Moody's Investors Service Singapore Pte. Ltd.
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