A deeper property downturn than currently anticipated could shave between 1.5 and 2 percentage points off China's GDP growth in the absence of an off-setting policy response, says Moody's Investors Service in a report.
Property sector weakness is likely to spread to the rest of the economy through supply chain linkages, including the construction, metals and machinery sectors, which would be credit negative for these sectors.
The report says that these supply chain effects would be large enough to shave between 1.5 and 2 percentage points off China's economic growth under the two scenarios.
"We expect that the Chinese government would respond to a growth slowdown of that magnitude, and we estimate that it has the policy space to do so without the sovereign rating coming under pressure," says Michael Taylor, a Moody's Managing Director.
Moody's current baseline scenario assumes a modest slowdown in the property sector with GDP growth in the 6.5-7.5% range, consistent with the stable outlook Moody's maintains on the sovereign and most of its rated portfolio.
Moody's has a negative outlook on the sector as a whole.
Moody's has developed two scenarios. The first one is that property sales volumes will fall by 10% this year and next, a level of decline seen in previous property slowdowns. In the second scenario, the fall in transactions combines with a 10% fall in property prices, an event which is not typical of previous property downturns.
Should either of the scenarios for the property sector threaten to materialize, Moody's expects that the central government would respond with a stimulus package to off-set the potential decline in GDP growth.
Moody's estimates that the impact of lower growth and a fiscal stimulus package aimed at containing the slowdown in economic growth to 5.5%-6% would only raise the central government's debt from 16% to 19% of GDP.
The sovereign rating would remain resilient to an increase in government debt of this magnitude.
A downturn in property transactions would also negatively affect the finances of local governments, which rely to a large extent on land sales as a source of revenue.
In the event that the central government would need to bail out some local government financing vehicles (LGFVs), Moody's estimates that every 10% of LGFV debt that needs such assistance would only amount to a little over 1% of GDP.