Bangkok--28 Jul--Standard & Poor's Ratings Services
Standard & Poor's Ratings Services said today it had raised its long-term sovereign credit rating on the People's Republic of China to 'A' from 'A-'. The outlook is stable.
At the same time, Standard & Poor's raised its long-term credit ratings on China Development Bank and Export-Import Bank of China to 'A' from 'A-'. The outlooks on the banks are stable. The ratings reflect their sovereign parent.
"The upgrade on the ratings on China reflects China's persistent efforts to strengthen the banking sector to reduce the future fiscal burden, as well as China's continuing economic liberalization and reform that will further entrench excellent growth prospects. At the same time, improving fiscal flexibility, robust external liquidity, and strong government commitment shield the country from most shocks, and facilitate the process of gradual restructuring. This has also led to progressive improvements in credit fundamentals since 1999," said Standard & Poor's credit analyst Ping Chew, of the Sovereign Ratings group.
Significant progress has been made through the government's ongoing restructuring of the financial sector. Continuing regulatory and supervisory strengthening, the efforts to clean up past bad loans, and the better quality of loan books (which have benefited from strong corporate cash flows) have led Standard & Poor's to lower its estimation of existing nonperforming assets in the financial system to 21%-25% of total loans by the end of 2005, which is expected to decline further. Foreign participation in China's financial system will also help to spread best practices, which in turn will improve the performance of the banking sector's credit underwriting. While the above range of 21%-25% is still among the highest compared to other banking systems, the contingent cost to the government is substantially lower, and allows better allocation of China's high savings rate (exceeding 50% of GDP) to more profitable investments.
China's high economic growth has engendered strong budgetary performances, with rising revenue, expected to reach 20% of 2006 GDP, and falling deficits, expected to be less than 1% of 2006 GDP. This strong budgetary performance allows the government to effectively deal with past excesses in the banking system and economy. China's foreign exchange reserve, already the largest in the world, will reach US$1 trillion before year's end, and is expected to increase with continuing current and capital account surpluses.
"Nevertheless, these strengths are offset by the high level of government debt and high contingent liabilities, the inadequacy of market institutions, and limited monetary flexibility," cautioned Mr. Chew.
The current cycle, especially the rapid loan and investment growth in the first half of 2006, highlight how China's structural rigidities, including its exchange rate and use of investment as a key driver of growth, have constrained monetary policy. This is further complicated by huge capital inflows and liquidity overhang. The authorities have to apply administrative measures to limit credit growth, rather than let market forces operate through pricing, exchange rate, and interest rates.
Nonetheless, the authorities have reacted early in this cycle, tightening monetary policy and attempting to limit unproductive investments. China's central bank raised its reserve requirement in July for the second time in two months to 8.5%. While current measures are only the first steps, Standard & Poor's expects ongoing efforts to moderate growth to more sustainable levels. More lending-rate hikes and monetary tightening, including gradual appreciation of the renminbi, are expected.
China's credit strengths are mitigated by high levels of government debt and contingent liabilities. Direct debt and bank recapitalization costs are expected to increase general government debt to 40% of GDP, which could reach 60%-70% of GDP, depending on the pace at which existing bad debts of the financial system are transferred onto the government balance sheet. Furthermore, China faces the challenge of building market and political institutions to govern an increasingly affluent and pluralistic market-oriented economy and society. Income inequality is still an unresolved problem that could increase social pressures.
The stable outlook reflects the expectation that China will maintain macroeconomic stability while it continues with its economic restructuring. By deepening market and economic institutions, and by raising the productivity of its nontradable sector, China would reduce investment inefficiency and raise income levels more quickly, leading to a positive outlook. Conversely, a slowdown of banking and state-owned enterprises reform, or policy mistakes that lead to a marked decline in economic activity, could result in a negative outlook. Any failure to manage the monetary environment presents the greatest risk to growth and banking system asset quality in the short term.
Complete ratings information is available to subscribers of RatingsDirect, Standard & Poor's Web-based credit analysis system, at www.ratingsdirect.com . All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com ; under Credit Ratings in the left navigation bar, select Find a Rating, then Credit Ratings Search.
Media Contact:
David Wargin, New York (1) 212-438-1579
[email protected]
Analyst Contacts:
Ping Chew, Singapore (65) 6239-6345
John Chambers, CFA, New York (1) 212-438-7344
KimEng Tan, Singapore (65) 6239-6350