Moody's: New US tax cuts have limited credit implications for China and Chinese corporates

Moody's Investors Service says that the new US tax law passed in December will not have material credit implications for China (A1 stable), one of the largest trading partners of the US, nor for Chinese companies, in terms of bilateral trade, the foreign exchange market, cross-border investment flows, and tax competition.

"Overall, the law's impact on China's fiscal position or capital flows will be limited" says Lillian Li a Moody's Vice President, "and the broader investment climate, rather than tax rates, will continue to guide inward investment to China."

"Furthermore, the US tax cuts will not materially affect the credit profiles of Chinese corporates, either in their domestic or overseas operations", adds Li.

Moody's conclusions are contained in its just-released report, "Cross-Sector — China: New US tax law has few credit implications for Chinese sovereign and companies". The report assesses the credit implications of the changes in US tax policy through four transmission channels: trade, currency effects, cross-border investment flows and tax competition.

On the issue of bilateral trade between the US and China, the tax cuts will produce only modest additional growth for the US economy and therefore will not materially increase US demand for Chinese exports.

Moreover, any positive impact may be offset by increasing trade tensions between the two countries.

The currency effects of the tax cuts will also be muted, with no additional downward pressure on the renminbi beyond the impact of above-trend US growth and Moody's expectations for rate hikes by the US Federal Reserve in 2018.

In addition, the impact on cross-border investment flows will be limited. Lower US tax rates are unlikely to result in significant changes to the future US investment plans of Chinese companies, given that Chinese government policy largely guides their outbound investment strategies.

Furthermore, Moody's does not expect significant cash outflows from US companies repatriating profits, and foreign companies are unlikely to change their investment plans, in light of the economic incentives, beyond tax considerations, to invest and operate in China.

China, however, is not highly exposed to such potential outflows, as most US investment in China has been in manufacturing. US multinationals are now free to repatriate their offshore profits without further tax under the new US tax policy.

Conversely, the US corporate tax cuts, even if they are mirrored in other advanced economies, are unlikely to change foreign companies' investment plans in China, given that these tend to be most influenced by longer-term structural factors, including expectations of continued fast growth in China's domestic market.

Finally, tax competition between China and the US is unlikely. The effective corporate tax rate for many companies operating in China is unlikely to be higher than the new US rate given various preferential tax policies from Chinese governments.

China's central government has reiterated its commitment to further reduce the corporate tax burden. Chinese companies also enjoy a competitive advantage through access to a lower cost of credit in China.

And although the US tax cuts will not have a material credit impact on Chinese companies that have operations in the US, these companies may have some incentive to adjust their US business operations or investment strategies.