BEIJING China must accelerate the pace of financial reform in coming months to sustain economic growth, ratings agency Moody's Investor Services said, forecasting the world's No. 2 economy will grow 7.5 percent each year from 2012 to 2014.
Expectations of steady expansion means China is unlikely to suffer any economic "hard landing," or abrupt slowdown, Moody's said, but warned that the days of easy growth for the world's fastest-growing major economy are over.
Difficult financial reforms that make space for a more market-driven system must be made to cut inefficiencies, it said. At the same time, China no longer enjoys the wide berth it had before to bolster growth in unforeseen downturns.
"Without more market-based price signals driving the efficient allocation of capital and improving the competitive delivery of services, China's trend growth rate will likely slow more rapidly than otherwise," Moody's said in a report.
Crucial areas of reform include increasing market-based competition, improving regulation to allow greater certainty and transparency on future rules and decisions, and making China's hulking state firms more efficient, Moody's said.
While these changes should uncover new engines of growth, the road will not be smooth sailing.
The 4 trillion yuan stimulus from Beijing four years ago that led to explosive growth in China's local government debt and rapid expansion of its banks means the country can no longer indulge in a credit binge if the economy swoons, Moody's said.
Banks were especially imperiled by China's previous credit extravagance, it said, noting China's total bank assets doubled in the past four years, leaving them exposed to industries now mired in excess production capacity.
Total assets in China's banking system are now worth 240 percent of the country's gross domestic product at 113.3 trillion yuan ($18.2 trillion), substantially higher than any other major emerging economy, Moody's said.
As a result, the agency judged Chinese bank asset quality to be "negative" for the next 12-18 months, even though it assessed the banking system to have a "stable" outlook in the period.
China's stabilizing economic growth has arrested the uptick in its banks' bad loan ratio, Moody's said, and there are no indications that asset quality will worsen materially in coming months.
DOUBTS OVER BAD DEBTS
China's four biggest state-owned banks which control about half of the country's total bank assets all have non-performing loan ratios of below 1.5 percent, drawing criticisms from analysts who say the numbers are too low and not to be trusted.
Christine Kuo, vice president of Moody's Financial Institutions Group, said while the agency too has its concerns about China's bad loan data, it cannot prove that the numbers are false.
"We have our concerns, but we have no evidence," Kuo said.
For state-owned enterprises, the economic slowdown will impact different sectors differently, said Kai Hu, vice president for corporate finance at Moody's.
Strategic sectors such as oil and natural gas production and the power grid will hang onto their monopolies, but consolidation measures recently announced by the government will be a blow to the dominance of state-owned enterprises (SOE) in other sectors.
Overcapacity remains a key obstacle, particularly in cyclical industries, Moody's said in its report, pointing out that capacity utilization in China had fallen to 60 percent in 2011 from 90 percent in 2000.
"We think the economic slowdown will be a challenge for SOE adaptability," Hu said.
Growing per capita income will increase cost pressure on companies, he added. Recent market reforms in energy prices will be a boon to suppliers of energy but add cost pressure to consumers.
($1 = 6.2302 Chinese yuan)
(Reporting by Koh Gui Qing; Editing by Jacqueline Wong)