Moody's: Chinese regional and local governments' economic and fiscal position will likely moderate in 2017

Moody's Investors Service says that the economic and fiscal position of regional and local governments (RLGs) in China (Aa3 negative) moderated in 2016 — according to key statistics — and this trend should continue through 2017.

Moody's assessment is mainly based on the fact that:

1) The central government trimmed its economic growth target to around 6.5% for 2017, 0.2 percentage point lower than 2016's outcome; and

2) The government maintains a proactive fiscal stance — for instance, by implementing tax relief and fee reductions measures — which will pressure the RLGs' fiscal status.

"The RLGs' budgetary revenues slowed in the fourth quarter of 2016, and the full year growth was at a three-year low," says David Rubinoff, a Moody's Managing Director. "We expect that such revenues will continue to slow in 2017."

"We note that the RLGs' economic and fiscal performance vary widely, with provinces heavily exposed to industries with overcapacity lagging behind," adds Rubinoff.

Moody's analysis is contained in its just-released report titled "Regional and Local Governments — China: Debt and Finances Snapshot."

Moody's points out that the RLGs' tax and non-tax revenues increased 4.2% year-on-year in 2016. Land sales — another major source of revenue — increased 15.1% in 2016. These revenues will be under pressure from the tighter government controls over the property market and slower economic growth in China.

The overall pace of economic growth continued to moderate for most RLGs in 2016. Debt and equity financing grew at a faster pace for about half of the 31 provinces. And, the pace of industrial production growth was on par with the levels in 2015 for most RLGs.

Likewise, the growth of fixed-asset investment increased in only eight provinces. While growth supported by policy stimulus might seem to minimize risks in the short run, such growth will likely leave unaddressed deep imbalances evident across regional economies, thereby increasing long-term adjustment costs.

As for the real estate sector, markets across China continued to stabilize. In 2016, 21 provinces reported increases in new residential and commercial real estate construction starts on an annual basis. Land price inflation strengthened in most large cities, especially with respect to land for residential property.

While residential property prices in major cities have surged rapidly over the past 6-12 months because of strong investment demand, Moody's believes the governments will strengthen their differentiated policies in the property sector to prevent prices overheating in first- and major second-tier cities, while supporting end-user demand in lower-tier cities where inventory levels are still high.

Moody's report also says that debt swap programs boosted the RLGs' bond issuance in 2016. During the year, the RLGs issued RMB6 trillion of bonds, 80% of which were for the debt swap program sponsored by the Ministry of Finance.

Since the program started in 2015, the RLGs have cumulatively swapped RMB8 trillion in non-bond government debt into bonds. This situation leaves RMB4.7 trillion of remaining debt to be swapped or paid down. While the central government's intention is to complete the program during 2017, the practical challenges, such as negotiating with diverse non-bank creditors, could delay the eventual swap of remaining RLG debt into 2018 or beyond.