Moody's: China has made substantial progress on reform and rebalancing

Moody's Investors Service says that China has made substantial progress on reforming and rebalancing its economy, since the government committed to deep reforms during the third plenary session of the 18th Central Committee of the Communist Party of China in November 2013.

"Substantial progress has been made on reform and rebalancing, and the general direction of government policy is supported by important initiatives such as the anti-corruption campaign and the One Belt, One Road strategy," says Michael Taylor, a Moody's Managing Director and Chief Credit Officer for Asia Pacific.

"However, there are two main tail risks to the relatively benign scenario that forms our core view, although we do not think either of them is very likely. The first would be an asset price correction in property or equities, and the second would be a rapid and ill-prepared liberalization of the capital account," adds Taylor.

Taylor explains that China's reforms and rebalancing of its economy involve balancing the following four factors:

1) The reorientation of the economy away from state-led, capital intensive investment towards private consumption;

2) Lowering the economy's dependence on credit-fuelled growth;

3) The implementation of policies that will allow markets to play a decisive role, to scale back on the government's role in the economy, and to enhance property rights; and

4) Ensuring that short-term growth does not fall substantially below the government's target of around 7%.

On the first factor, Taylor says there is evidence to suggest that China's restructuring process is advancing steadily, with the services sector growing more strongly than either mining or other extractive industries or manufacturing.

However, on the second factor, Taylor says evidence of progress is more mixed, although efforts to introduce greater differentiation into credit markets are beginning to show results. Taylor also points out that while credit growth is slowing, the deleveraging process has only just begun.

As for the third factor, Taylor says evidence suggests that the government's reform processes are gathering pace, with financial sector reforms in particular having made substantial progress.

In addressing the final factor, Taylor reiterated Moody's position that China's economy will avoid a hard landing because of the numerous policy tools available to support a managed slowdown.

On the risk of a property price correction, Taylor says the effects of supportive monetary and regulatory polices implemented since the second half of 2014 have started to gather momentum; indicating that a sharp decline in the property market is unlikely.

However, even if the property market has stabilized, it will take some time before substantial new construction projects are undertaken, given the large inventory overhang. In addition, the downturn in construction is likely to negatively affect economic growth over a prolonged period, given Moody's estimate that the property supply chain makes up as much as one quarter of China's GDP.

As for China's capital account, Taylor explains that for more than two decades, China has gradually removed exchange controls in a carefully managed process.

However, rapid and ill-prepared liberalization of the remaining capital controls could present significant risks. Depending on their net effects, large capital flows into and out of the country could either put upward pressure on the exchange rate -- placing exporters under pressure -- or lead to higher costs of capital, especially for state-owned companies.

Taylor was speaking at Moody's China Credit Risk Conference in Shanghai on 12 June 2015.

Moody's conferences will feature the following workshops:

The Outlook for Regional and Local Governments; and
China Securitization: Market Overview and Outlook

The conferences will also feature the following panel discussions and presentations:

Default: After the Automatic Bailout Era
How the Change in the Credit Cycle Will Affect Steel and Mining Firms, and Other Sectors with Overcapacity

China Banks: Assessing the Credit Impact of the Latest Market Developments
Funding China's Massive Infrastructure Needs

How Well the Sovereign Balance Sheet Can Absorb Contingent Liabilities
The details on Moody's China Credit Risk Conferences: When Markets Play a Decisive Role are as follows:Shanghai

Moody's offers complimentary access to its new topic page, China -- Reform and Rebalancing, a centralized source for Moody's research related to key credit issues in China as the country's rebalancing story unfolds. This conference is part of Moody's ongoing coverage on this theme. Register today at www.moodys.com/chinarebalancing for access to all research on this page.

Recent Moody's publications relating to China Reform and Rebalancing include:

China Will Allow Select Banks to Issue Negotiable Certificates of Deposit, a Credit Positive

China Property Sector Outlook: Modest Growth As Government Policies Begin to Work, Explaining Moody's Change in Outlook to Stable from Negative (Presentation)

China Railway Sector: Government Rail Investment Is a Key Credit Support for Selected Chinese Issuers

Sub-Sovereign: Chinese Policies Allow Higher Leverage for Local Government Financing Vehicles, a Credit Negative

Chinese Province Extends Maturity Schedule with First 2015 Bond Issuance

China's Healthcare Reforms Benefit Large Pharmaceuticals (Presentation)

Chinese Banks: Government Support to Remain Strong But Become More Nuanced

China: China's Interest Rate Reduction Is Credit Negative for Banks

Sub-Sovereign: Chinese Regional and Local Government Bonds Qualify as Collateral for Central Bank Lending Facilities, a Credit Positive

Chinese CMBS: Anchor Tenants Offer Cash Flow Stability, But Limit Property Valuation Potential If They Are Weak

These reports are available at http://www.moodys.com/chinarebalancing.