RPT-Fitch: Small China stimulus highlights growth, reform challenges

Fri Jul 26, 2013 5:22am EDT

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July 26 (Reuters) - (The following statement was released by the rating agency)

The limited size and scope of the stimulus measures announced by China's State Council Wednesday is in line with the relatively cautious and targeted approach to stimulating the economy seen so far this year, Fitch Ratings says. The Chinese authorities are currently refraining from deploying large-scale stimulus of the kind previously used to contain the impact of the global financial crisis on growth.

Recourse to credit-fuelled, investment-led stimulus, as was seen in the second half of last year, would exacerbate the structural weaknesses in the economy, which would be credit negative. The key structural economic weaknesses are reliance on investment to drive growth and an associated run-up in leverage, both of which are unsustainable in the longer term.

We expect the Chinese economy to grow at 7%-7.5% out to 2015 (we cut our forecast for 2013 to 7.5% from 8% in our June Global Economic Outlook), consistent with our base case of a gradual rebalancing as outlined in recent comments from China's senior leadership. Continued consumption growth even at the bottom end of the range seen in 2006-2012 can help maintain this growth rate even if investment growth slows. Furthermore, the labour market has so far remained resilient as growth has come down to about 7.5%, helping maintain social stability.

The measures announced Wednesday included temporary tax cuts for businesses with sales of less than RMB20,000, and moves to simplify administration and approvals for exporters, along with initiatives to support railway financing. The focus on small and medium-size enterprises may be a response to the slowdown in SME-related manufacturing seen in recent months (SMEs have a heavier weight in in the HSBC/Markit PMI Index, which recorded a preliminary reading of 47.7 in July - the third straight month that the reading has been below the 50 level that indicates contraction). Evidence of weakness in activity has emerged despite continued credit growth, suggesting that incremental growth generated from credit has weakened.

The recent scrapping of the loan rate floor for bank lending suggests that the new administration headed by Xi Jinping and Li Keqiang has some appetite for structural reform, although the impact of this specific measure will probably be small as few loans were priced at the floor. Additional financial reform could help facilitate rebalancing by ensuring capital is priced in line with market forces, discouraging less productive investments. Appropriate fiscal reform could also reduce the need for local governments to borrow via shadow banking channels.

We downgraded China's Local-Currency Issuer Default Rating to 'A+' from 'AA-' in April, reflecting the growth of general government indebtedness - driven at the local government level - since 2008, and our concern over risks to China's financial stability because of continued rapid credit growth. The Outlooks on the LC IDR and on China's 'A+' Foreign Currency IDR, which is supported by the strength of the sovereign's foreign currency balance sheet, are Stable.

A repeat of the much bigger stimulus programmes of recent years would exacerbate the economy's structural weaknesses and put pressure on the ratings, as would a significant and sustained slowdown in growth that led to a rise in unemployment and intensified social and political unrest. Conversely, if economic rebalancing proceeds smoothly over the next 12-18 months and we became confident that the hangover from the 2009-2010 credit surge is under control, this could ultimately lead to an upgrade, although this is unlikely within our two-year Outlook horizon.

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