RPT-Fitch: China Reform Drive Subject to Full Employment Constraint

Mon Mar 17, 2014 8:04am EDT

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March 17 (Reuters) - (The following statement was released by the rating agency)

Recent weak Chinese economic data underscore the challenge facing China's authorities in pursuing economic reform and rebalancing without letting growth slow too abruptly, says Fitch Ratings. Fitch thinks the Chinese authorities remain committed to reform, but are subject to the constraint of maintaining full employment.

Chinese data are highly seasonal, and first quarter weakness is normal. But we think the January-February data show a genuine slowdown, reflecting in part the previous monetary policy tightening. The flow of new aggregate financing in January and February dropped 2.5% from the same period last year, to CNY3.5trn, according to the People's Bank of China. Interbank rates and bond yields have risen since mid-2013, although they have dropped back again since mid-February.

Retail sales growth in January and February slowed to 11.8% yoy, from 13.1% for 2013 as a whole. Fixed-asset investment growth was 17.9% yoy, with equipment purchase the weakest category. Retail sales and investment showed the weakest readings since 2003 and 2002, respectively (on a year-to-date, yoy basis). Export growth was just 0.5% yoy in the three months to end-January 2014.

We think tighter monetary and credit conditions are aimed at reining in credit growth, particularly "shadow banking" activities perceived as riskier for financial stability. The slowdown also coincides with the government signalling a shift towards greater tolerance of corporate defaults by allowing China's first onshore corporate bond default in recent times, by Shanghai Chaori Solar Energy Science and Technology. In the long term, we think this is positive for China's financial system as it should instil greater market discipline and lead to a more efficient allocation of capital among corporate borrowers. It may also pressure weaker borrowers' liquidity, and increase their onshore borrowing costs.

But policy-making has been "stop-go", as the authorities try and find the balance between squeezing out riskier activity and maintaining a full-employment rate of growth. The net result of this process in 2013 was that the economy became more credit-dependent and investment grew faster than consumption. Fitch estimates the total stock of credit rose to about 217% of GDP by end-2013, from 198% at end-2012.

China's main economic targets for 2014 are unchanged from 2013, a year when the economy's structural vulnerabilities intensified marginally. Nonetheless, we think the year-old top leadership team remains committed to the kind of reform agenda articulated in the Third Party Plenum in November 2013.

Premier Li Keqiang reiterated on 13 March that there is "a certain degree of flexibility" in the 2014 target of about 7.5% growth, and said that China has "the ability, and all the means" to keep growth "within a reasonable range." At least two government-commissioned studies in 2013 suggested growth of about 7% was the lowest rate consistent with full employment. Labour market data point to a sustained surplus of vacancies over jobseekers in the urban labour market. We expect growth of about 7.3% in 2014.

We also view the People's Bank of China's tolerance of greater exchange-rate volatility as a financial-stability measure, aimed at deterring some speculative activity driven by perceptions of inevitable yuan appreciation. However, if domestic demand fell sharply - for example, because of problems in the financial system - the authorities would retain an option to give back some of the yuan's 15.8% trade-weighted appreciation since end-2010.

We rate the China sovereign 'A+' with a Stable Outlook. The key vulnerability in China's sovereign credit profile remains the unsustainability of investment-driven growth and uncertainty over the timing and impact of resolving weaknesses in the financial system.

Our Chinese growth forecasts are discussed in our "Global Economic Outlook", available at www.fitchratings.com, where details are also available of our Sovereign Credit Briefings in Hong Kong and Singapore this week.