Country risk: Where next for China investment risk?

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The Moody’s downgrade of China in May has given investors plenty to think about. The country’s long-term issues need to be addressed urgently.


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By Claudia De Meulemeester 

There’s plenty to rattle China investors right now, as shown by Moody’s recent credit-rating downgrade, while Euromoney Country Risk data shows that all Chinese territories are experiencing a gradual decline in investment.

Ever-growing concern around China’s debt levels and financial strength led Moody’s to downgrade the country’s credit rating from Aa3 to A1 on May 24. The last time the credit rating agency downgraded China was in 1989, the year of the Tiananmen Square protests. The immediate consequence of this downgrade is likely to be a slow increase

in the cost of borrowing for the sovereign and for its state-owned enterprises.


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The challenges ahead for China are enormous, and doubts abound on how the country will cope with its failing SOEs, struggling housing market, capital flight, huge amounts of debt and far-from-transparent political system.

“It will get much worse before it gets better,” says Harry Broadman, chief executive of advisory firm Proa Global Partners. “China is a socialist economy tied up in a war of words.”

China’s growth figures in the last few decades have been impressive, but since 2011, its ECR scores have been declining. Its long-term issues need to be addressed urgently. 

A recent report from EY reviewing 37 Chinese listed banks in 2016 states that “both non-performing loan (NPL) balances and NPL ratios continued to rise due to a combination of macroeconomic slowdown, increased risk exposure to industries burdened with overcapacity, and adjustments to commodity prices.” 

And the situation is not improving. According to the same report, the NPL balances for 28 Chinese banks that disclosed their first-quarter results for 2017 reached more than Rmb1.2 trillion ($176 billion), up Rmb24 billion from the previous quarter.

Exports were long the driver of China’s GDP growth, but those days are gone. The Chinese economy needs a new business model as overcapacity is reaching unsustainable levels. The restructuring and consolidation of the country’s SOEs is particularly complicated and will require a new approach.

“Investment in the mainland will increasingly head towards the services sector as the Chinese government looks to rebalance the economy towards one that is more reliant on consumption instead of investment and heavy industries,” says Chua Han Teng, senior analyst at BMI Research.

Innovative

Foreign investors seem harder to attract because of the concerns about capital flight and predictions of a continuing slowdown of the economy. Still, China is under pressure and is aware it has to reform in order to progress. 

Broadman suggests the country might be far more innovative than is commonly thought. “Ten years from now, China might emerge as leader of green infrastructure. You can’t just change from one day to another, but the Chinese understand the health effects and are more committed to the green economy than the US.”

The transformation from an export-driven economy to an efficient domestic services market is as much a political task as an economic one.

The economies of Hong Kong and Taiwan are closely entwined with that of the mainland and, despite political tensions, increasingly integrated. Any decision-making in Beijing will necessarily affect the other territories directly as well.

ECR scores for China have remained fairly stable over the last quarter, though there was a slight fall in the political assessment. Its score is down to 48.19 in the first quarter of the year from 48.27 in the last quarter of 2016.

Given geopolitical issues with North Korea and the unclear foreign policy agenda of the new US administration, this decline is not surprising. Still, Broadman adds, “what keeps the Chinese government awake is the people at home, not what the White House says.”

The question is to what extent China will be able to direct its growth in the coming years, and what effect that will have on neighbouring economies that are heavily reliant on Chinese investment.

“Despite global concerns, Asia (ex-Japan) should continue to be the driver of global economic growth for the time being,” according to Carl Tannenbaum, chief economist at Northern Trust. “Chinese policymakers have repeatedly surprised analysts with their ability to sustain the status quo.”

Learn more about ECR at euromoneycountryrisk.com