Rating action

Scope Ratings GmbH (Scope) has today affirmed the People’s Republic of China’s long-term local- and foreign-currency issuer and senior unsecured debt ratings at A, and maintained the Stable Outlook. The short-term issuer ratings have been affirmed at S-1 in local- and in foreign-currency, with Stable Outlooks.

The affirmation of China’s long-term credit ratings reflects a large and well-diversified economy, supported by the development of high-quality industries such as in advanced technologies and green energy, with a comparatively high although declining medium-run trend rate of growth compared against that of peer economies. In addition, strong resilience to external crises, underpinned by the globe’s largest stock of international reserves, strong exporting-sector performance, and low external and foreign-currency-denominated debt, reflects a credit strength. This furthermore recognises the renminbi’s growing status as a global reserve currency – particularly for nations of the Global South. Although general government debt is very elevated for an emerging economy, central-government debt is comparatively moderate although slowly increasing. Finally, the central government’s capacity for speed and efficacy of targeted reform, including extraordinary macro-prudential measures, supports the credit ratings.

China’s core credit challenges are significant, persistent budgetary deficits at the general-government level and fast rising general government debt, specifically of local governments, as well as financial imbalances linked to rising economy-wide debt, the property-market downturn and corporate-sector defaults.

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Key rating drivers

Large and well-diversified economy, with comparatively stronger trend growth than economies of sovereign peers. The Chinese economy is the world’s largest by purchasing power – underscoring significant credit strengths. The economy grew 5.2% last year, supported by a rebound of consumption. Output growth was a still-robust 5.3% YoY in Q1 this year – driven by the manufacturing sector and industrial output. Economic momentum has decelerated, however, by Q2 – seeing below-expectation growth of 4.7%. This was underscored by a prolonged slowdown of the property sector, low wage growth and industry cost cutting. Scope sees real growth of 5% for the year as a whole – if so, achieving authorities’ growth objective of the year – before 4.5% next year. Scope assumes growth continues to converge towards a lower medium-run trend rate of 4% over the years after. Although growth has moderated from the very-high rates of the past decades, average growth remains above that of most economies globally.

Nevertheless, weakening demographics represent a long-run challenge. Last year, the population declined by around two million, after an 850,000 drop the previous year. The United Nations projects the population to decline 113m (or off 8%) by 2050. This is although output is seen continuing to be supported by development of high-quality industries within sectors such as high-tech and green energies, as well as by a competitive exporting sector. On the demand end, real-estate investment is seen staying subdued given prolonged balance-sheet distresses of property-sector developers. Stimulus approved for private demand to bolster consumer confidence and easing of monetary policies have been rolled out gradually. The People’s Bank of China recently cut the seven-day reverse repo rate 10bps to 1.7% and the one-year policy rate 20bps to 2.3% given very-low inflation of just 0.2% year on year last month. Scope assumes inflation staying under 3% central-bank objectives, averaging 0.2% this year before 1.8% next year.

Strong external-sector resilience, underpinned by elevated foreign-exchange reserves, limited external debt and internationalisation of the renminbi.

China’s current-account balance has stayed in surplus, averaging 1.9% of GDP between 2020 and 2023, despite supply-chain disruptions and weaker global demand. Exports have recovered steadily since Q3 of last year – peaking at 8.6% annual growth last month, driven by the export of goods such as electric vehicles, batteries, semi-conductors and biotechnologies. This has helped compensate for annual services-trade deficits, furthered by the gradual recovery in outbound tourism. The IMF forecasts the current-account balance staying in a modest surplus of slightly above 1% of GDP over 2024-29¹.

The net international investment position (NIIP) increased to 16.3% of GDP by the end of last year, from 12.3% at end-2021, although staying below 30.2% peaks of 2008. The moderate decline of the past decade of the net international asset position was driven by higher inward foreign direct investment (FDI) as well as inward securities investments. The NIIP is seen staying in a net-asset position but nevertheless gradually edging nearer to balance medium run. FDI inflows reached record highs of USD 344bn in 2021 (or 1.9% of GDP), but flows slowed since 2022, reflecting slowing economic growth and a weaker renminbi due to divergences of People’s Bank of China policies from that of global central banks. Nevertheless, the strong external sector mitigates adverse effects of scenarios of further imposition of tariffs and levies on Chinese goods by trading partners such as the European Union, United States and Latin-American partners following recent announcements of import duties.

Resilience against currency sell-off episodes is furthermore bolstered by the nation’s sizeable foreign-exchange reserves, stable recently around USD 3.2trn, still representing today 26% of all foreign-exchange reserves globally. In addition, China’s ratings are supported by limited external debt amounting to USD 2.5trn (only 14.2% of GDP) as of Q1 2024, and limited government debt in foreign currency. Sizeable reserves support economic stability during phases of capital outflows and depreciation pressure. The real effective exchange rate (CPI-based) devalued 13% to June 2024 from peaks of March 2022.

In addition, the renminbi continues to make progress as a global reserve currency even though yuan claims within total global allocated forex reserves remain below that of dollar, the euro, yen and sterling (with the former at 2.1% in Q1 2024, compared against the dollar at 58.9% and euro at 19.7%). The IMF revised special-drawing-rights weightings in 2022, seeing yuan’s weight increase from 10.9% to 12.3%. China has increasingly conducted trade in local currency.

China’s central government exerts significant control over many economic sectors. This supports the speed and efficacy of targeted reforms, including of extraordinary macro-prudential measures. The government retains significant controls over the banking system and is able to advance policies for achieving soft economic landing by enforcing rapid deleveraging of over-indebted sectors and enforcing targeted defaults. The quinquennial economic-reform meeting (‘Third Plenum’) outlined goals of transferring some non-tax revenue collection to local governments, raising the share of central fiscal expenditure in government spending, and setting up a system for monitoring and regulating over-indebted local governments. In addition, reforms to gradually delay retirement ages and incentivise births were presented. Outstanding controls over the economy furthermore raise implicit resources of the sovereign under stressed scenarios – decreasing sovereign credit risk.

Although the unique economic model of China enhances the capacity of the government to bring about fundamental reform, it can also have credit-negative implications if unchecked authority results in lower quality of governance and policy making over the long run.

Ratings challenges: significant public-sector deficits, rising public debt and outstanding financial-system imbalances.

The general government debt of China has risen significantly from 27.2% of GDP at 2008 lows reaching 83.6% of GDP by last year. Due to China’s unique structure of debt, this past general government debt rise has been primarily driven by rising debt of local governments – a contingent liability. Central government debt of China remains moderate at 24% of GDP as of Q1 2024, nevertheless up from 14.3% a decade before. Scope expects debt under the general-government definition to reach 110% of GDP by 2029. In addition, given stress on local-government balance sheets, a greater share of the rise over the forthcoming years is seen being driven by explicit central-government debt.

Under an IMF ‘augmented’ definition, which includes local government financing vehicles and other off-balance-sheet entities, debt is higher while the increasing debt trajectory is slightly steeper. By such a definition, debt is anticipated to be 143% of GDP by 2028¹, up around 26pps from end-2023 levels. The debt of China under general-government and augmented definitions is very high compared against sovereign peers having similar wealth levels, although China retains ample domestic savings and the central government maintains net assets.

The general government deficit rose to around 7% of GDP last year. Scope anticipates budget support to stay in place this year, given Ministry of Finance² planning of borrowing RMB 1trn in long-term special bonds. This underscores an assumption of a general government deficit of 7.3% of GDP for this year, before averaging 7.7% of GDP over 2025-29. The central-government budget target has been set at 3% of GDP for this year.

Financial imbalances consider elevated economy-wide debt and corrections within the property sector. The introduction of the ‘three red lines’ in 2021 brought contraction of real-estate investment and failure of property-sector developers, impeding the completion of pre-sold housing. The pace of real-estate developers’ restructuring has been slow. Consequently, authorities have appropriately introduced some measures³ mitigating corrections in the property market.

The prolonged slowdown in residential investment, together with low mortgage demand and increasing mortgage prepayments, has also had an adverse effect on the banking system, given decreasing interest income and deterioration of asset quality, although forbearance has helped hold reported non-performing loans low at 1.6% of gross loans as of Q1 2024. Nevertheless, capital ratios of the banking system remain low compared against those of peer banking systems and risks are especially pronounced for smaller banks, having lesser capital and less loss-absorption capacity.

Outlook and rating sensitivities

The Stable Outlook represents the view that risks to the ratings over the forthcoming 12 to 18 months are balanced.

Upside scenarios for the rating and/or Outlooks are if (individually or collectively):

1. The renminbi and Chinese government bonds made substantive gains as reserve currency and global safe asset respectively;
    
2. Public finances strengthened materially, resulting in a stabilisation of the public-debt trajectory; and/or
    
3. Economic and financial reforms re-anchored financial stability and stable long-run growth.

Downside scenarios for the rating and/or Outlooks are if (individually or collectively):

1. A maintenance of a weak budgetary outlook and/or crystallisation of additional contingent liabilities observe the continued rise of general- and central-government debt levels;
    
2. A significant financial and/or economic crisis materialises, impairing financial-system stability; and/or
    
3. China’s external-sector resilience weakens materially.

Sovereign Quantitative Model (SQM) and Qualitative Scorecard (QS)

Scope’s SQM, which assesses core sovereign credit fundamentals, signals a first indicative credit rating of ‘bbb+’ – approved by the Rating Committee – for China. Under Scope’s methodology, this first indicative rating receives: i) a one-notch positive adjustment from the methodological reserve-currency adjustment; and ii) an offsetting one-notch negative adjustment from the political-risk quantitative adjustment. On this basis, final SQM quantitative ratings of ‘bbb+’ are assigned and reviewed by the Qualitative Scorecard (QS). Under the analyst-driven QS, the final indicative rating can be adjusted by up to three notches up or down based on the significance of China’s qualitative credit strengths or weaknesses compared against a model-assigned peer group of sovereigns.

Scope identified the following QS relative credit strengths of China: i) growth potential and outlook; ii) monetary policy framework; iii) macro-economic stability & sustainability; iv) debt profile and market access; v) external debt structure; vi) resilience to short-term external shocks; and vii) financial sector oversight and governance. Furthermore, Scope identified the following relative credit weaknesses against sovereign peers: i) fiscal policy framework; and ii) financial imbalances. On the aggregate, the QS generates a net two-notch downside adjustment of the ratings, resulting in final A long-term ratings.

A rating committee has discussed and confirmed these results.

Environment, social and governance (ESG) factors

Scope explicitly factors in ESG issues in its ratings process vis-à-vis the sovereign-rating methodology’s stand-alone ESG sovereign-risk pillar, which holds a significant 25% weighting under the quantitative model (SQM) and 20% weight under the methodology’s qualitative overlay (QS).

On environmental factors, China scores weakly under the SQM on carbon- and greenhouse-gas emissions intensity as well as on the ecological footprint of consumption compared against available biocapacity although it performs slightly above a global median on natural disaster vulnerabilities (as measured by the ND-GAIN Index). China is the globe’s largest emitter of carbon dioxide, accounting for around one third of global CO₂ emissions. Although meaningful progress is being made on curtailing the carbon intensity of the economy, the World Bank references significant policy and regulatory reforms being needed to meet targets of stopping the growth of emissions by 2030. The 14^th five-year plan defined specific targets regarding energy and the green transition that were broadly in line with authorities’ current climate commitments to carbon neutrality by year 2060. As such, complementing a very-weak score on environment for China under the quantitative model, Scope assigns a ‘neutral’ assessment for China under ‘environmental factors’ under the QS.

For social factors captured by the SQM, China performs better than a global median on labour-force participation and the old-age dependency ratio. But it has below-average scores on income inequality. Significant social progress has been achieved over the recent years, including progress on poverty alleviation, education and health. Moreover, the five-year plan shifted towards greater concentration on the quality and efficiency of economic growth and citizens’ lives, with prioritisation around bolstering social safety nets, curtailing urban-rural inequalities and property-rights reforms. Nevertheless, social safety nets are inadequate as less than half of urban employees are ordinarily covered by unemployment insurance, alongside even lower rates for rural households. According to the World Bank, expenditure on health of around 5.3% of GDP remains slightly under that of other upper middle-income economies (5.8%) although the gap has narrowed during the recent years. Although China’s old age dependency ratio is currently healthier than that of advanced economies, the rapidly-ageing population presents challenges for the social-security system. This underscores a ‘neutral’ assessment for ‘social factors’ under the complementary QS.

Finally, under governance-related factors captured by the SQM, China scores below average on the World Bank Worldwide Governance Indicators. The country ranks especially low on voice and accountability, although scoring on other sub-categories such as rule of law and control of corruption have improved over the recent years. The country’s score on political stability drives a one-notch negative adjustment to model indicative ratings. Although the power consolidation achieved by President Xi Jinping strengthens reform momentum near term, Scope believes this may reduce the quality of governance and policy making long run. This balance underscores a ‘neutral’ assessment for China under ‘governance factors’ within the QS.

Rating committee
The main points discussed by the rating committee were: i) ratings history; ii) third plenum; iii) budget deficits and debt trajectory; iv) general government debt structure; v) financial stability; vi) property sector; vii) internationalisation of the renminbi; viii) inflation outlook; and ix) sovereign peers developments.

Rating driver references
1. International Monetary Fund – People’s Republic of China: 2023 Article IV Consultation, February 2024
2. Financial Times – “China’s treatment of local debt ‘ulcer’ threatens growth target”, March 2024
3. Financial Times – “China has finally unveiled its property rescue plan. Will it be enough?”, May 2024

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 29 January 2024), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and/or Outlooks is (Sovereign Quantitative Model Version 3.0), available in Scope Ratings’ list of models, published under https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party Participation    NO
With access to internal documents                                  NO
With access to management                                           NO
The following substantially material sources of information were used to prepare the Credit Ratings: public domain.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings and/or Outlooks were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Dennis Shen, Senior Director
Person responsible for approval of the rating: Alvise Lennkh-Yunus, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Credit Ratings/Outlooks were last updated on 12 May 2023.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use / exclusion of liability
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