Moody's: Slower growth and rising credit risk are symptoms of China's challenge of structural rebalancing

Moody's Investors Service says that slower economic growth and rising credit risk are symptoms of the challenge that China (Aa3 stable) faces with structural rebalancing and are developments which have become more prominent since mid-2015.

"Recent events have tended to illustrate the scale of the task confronting the authorities in managing the policy trade-offs involved in structural rebalancing," says Michael Taylor, a Moody's Managing Director and Chief Credit Officer for Asia Pacific.

Moody's defines China's rebalancing challenge as the need to engineer economic restructuring, policy reform, market liberalization, and slower credit uptake with the aim of shifting economic growth drivers away from state-led investment -- all without sacrificing short-term macroeconomic stability.

"While there is evidence that the economy is gradually re-orientating away from state-led, capital-intensive growth, the trade-offs are slower headline economic expansion, accelerating capital outflows, and a less certain policy trajectory," says Taylor. "System leverage also continues to rise despite slower credit growth."

Moody's conclusions are contained in its just-released report titled, "China Credit: Slower Growth and Rising Credit Risk Are Symptoms of Rebalancing."

Moody's believes that the government's enduring growth concerns will test its ability and willingness to implement long-term economic policy and market liberalization objectives that could have negative short-term effects on growth.

In this context, the pace of structural reform -- which is nevertheless proceeding -- will remain gradual and subject to implementation delays or temporary reversals.

"As the authorities are -- we believe -- prioritizing stability in the current environment, the likelihood of a slowdown in policy reform is increasing," says Rahul Ghosh, a Moody's Vice President and Senior Research Analyst. "In addition, our GDP growth forecasts for China of 6.8% in 2015 and 6.3% in 2016 are based on the assumption that the authorities will further step up monetary and fiscal measures in the face of weakening aggregate demand."

Moody's forecast of a further GDP slowdown is supported by the pervasive weakness of indicators, such as the country's purchasing managers' indices, credit growth, fixed asset investment and weakening labor market conditions.

To date, the policy stimulus measures that have been implemented have been broader-ranging and larger than what Moody's had expected at the start of the year.

Such measures include ongoing monetary easing to help support onshore liquidity, including interest rate and reserve requirement ratio cuts, and fiscal support focused on supporting infrastructure and public works investment.

Despite the additional policy stimulus, Moody's expects evidence of stress in the banking sector and public bond markets in China to rise, as sustained slower growth and capital outflows undermine overstretched balance sheets in the corporate sector.

"One consequence of rising corporate distress is that contingent liabilities for the sovereign may begin to crystallize and capital outflows may persist. Such trends could weaken, over the year, China's very strong fiscal and balance of payments ratios, although these ratios are likely to remain stronger than those of similarly rated sovereigns," says Taylor.