China Avoids Hard landing; Sustained Growth Depends on Reforms

Moody's Investors Service says that China's economy is recovering and a hard landing is becoming more and more an unlikely and distant possibility.


In addition, while Moody's considers the rebound in growth as positive, it can also -- to the extent that it depends on an ample availability of financial credit and if it is left unchecked -- exert credit pressures over time, perhaps offsetting the initial advantages for the economy.


At the same time, the Mainland's new leadership looks committed to financial-sector, fiscal and structural reforms, and the orderly transition to the country's fifth generation of political leaders has reduced uncertainty for investors.


Moody's conclusion of the presence of a recovery is supported by forward-looking indicators, such as the purchasing managers' index, which point towards ongoing near-term economic expansion.


In addition, early signs of a rebalancing in the economy represent another positive, as consumption contributed slightly more than investment to overall GDP growth in 2012. Stabilisation in the global economy has boosted China's export performance and supports the country's growth rebound.


Recent data releases also point to a rebound in economic activity and suggest real GDP growth should climb to the upper half of the 7.5% to 8.5% range Moody's forecasts for 2013, up from 7.8% in 2012. The favourable growth outlook is supported by policy easing and credit extension, particularly by the non-banking sectors, and should continue in 2014.


Moody's conclusions were contained in its latest sovereign report on China (Aa3 positive), titled "Improved Economic Outlook for 2013 Is Underpinned by Policy Easing."


According to the report, China's economy enters 2013 on a relatively stronger footing than 2012, as reflected in Moody's revised growth forecast of 8.0%, up from real GDP growth of 7.8% in 2012, with upside risks.


The authorities' pursuit of a policy of calibrated stimulus measures has helped the rebound in aggregate demand in China, and which was also reflected in the stronger retail sales and industrial output apparent in the fourth quarter.


Recent developments suggest that fiscal policy has also become more expansionary and is supporting growth, and will also ease budgetary pressures at the local government level. Moody's estimates that China's general government budget deficit was slightly higher at around 1.5% of GDP in 2012, compared with 1.1% in 2011.


Moody's expects that fiscal policy will continue to provide more support to growth this year and next, and that the budget deficit will widen modestly and prudently.


However, while the development of the non-bank financial system, including the banks' off-balance-sheet wealth management products, is needed to help the financial system diversify, growth from this sector was extraordinarily rapid in 2012.


Accordingly, if non-bank credit growth is left unchecked, or regulators and financial institutions are unable to adequately manage the associated risks, or moral hazard is allowed to emerge when investors face losses, negative consequences could become apparent for macroeconomic stability and the soundness of the banking system, which remains the key mechanism for financial intermediation.


Given the evolving environment, Moody's believes that China's new political leadership faces a new challenge in modulating the rapid rise in aggregate financing to ensure long-term macro-economic and financial system stability. To that end, the authorities appear -- as recently indicated by the recent long-term income distribution stragegy outlined by the State Council -- committed to furthering financial-sector, fiscal, and structural reforms.


But the pace at which such reforms can be achieved will be crucial for determining whether a rebalancing of the economy away from its heavy reliance on investment, and increasingly on leverage, is successful.

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