China’s growth focus may push debt higher on stepped-up fiscal support: Fitch

December 21, 2023 (MLN): The Chinese government’s indications that policy measures next year will prioritize development and provide greater assurance about China's economic growth prospects could result in higher fiscal deficits and debt than expected previously, at a time when contingent liability risks have increased for the government, says Fitch Ratings.

Government statements following the recent Central Economic Work Conference reinforce our view that fiscal policy will be a bigger part of the policy toolkit for next year.

The rating agency believes this will involve more support from the central government, resulting in a wider national fiscal deficit in 2024 than we currently assume.

Fiscal measures are likely to remain focused on supporting investment, but broader tax reform remains a possibility. Monetary policy appears set to play a more modest role in supporting growth.

Fitch affirmed China’s rating at ‘A+’/Stable in August 2023. Further weakening of the sovereign's public finances could add to downward pressure on China’s rating, given the erosion of its performance relative to peers on these metrics in recent years.

Moreover, it expects firmer policy support to curb downside risks to economic growth and view the announcements as being in line with Fitch’s projection of slowing growth at 4.6% in 2024, from an estimated 5.3% in 2023.

However, there is a risk such support could still be insufficient to prevent a slowdown sharper than the one we expect.

The deceleration under Fitch's baseline scenario reflects that underlying economic momentum remains subdued amid continued property-sector stress, without the post-pandemic reopening boost that lifted the headline growth rate this year.

Slowing nominal GDP growth suggests elevated risks to the sovereign balance sheet from contingent liabilities in the next few years.

It further believes that the post-conference statements are consistent with our projection that local and regional government expenditure will return to growth in 2024, supported by stabilizing revenue inflows and growing debt.

The call to reduce structural tax and fee levels may affect revenues adversely, but we expect such reductions to mostly favor high-tech and innovative manufacturing sectors.

The impact on total revenue should not be significant, as these companies are not usually major tax contributors to local governments.

The authorities have indicated they will broaden the permitted scope of project types for local government special-purpose bonds (SPBs) used for capital injection into projects.

Mobilizing more project financing with SPB issuances could support growth, but could also increase credit exposures for local governments associated with such projects, particularly if the central government also intends to relax minimum return standards for SPB-related projects.

More local government financing vehicles (LGFVs) may set up industrial investment funds or provide other support to industrial development, given the government's increased emphasis on the importance of industrial investment.

This could increase public-sector liabilities for local governments, and indirectly for the sovereign.

That said, the associated risks would depend on the success of such investments and the health of each region's public finances.

Post-conference announcements have also called on economically stronger provinces to contribute more to supporting growth. We believe authorities in these regions will have access to more favorable financing or sector growth policies next year.

Their more active role may allow more fiscal revenue to be diverted by the central government to support economically weaker regions.

A greater focus on preventing systemic risks, highlighted in the statement, could also signal tougher monitoring of LGFVs, increasing the likelihood that potential debt repayment problems will be caught and resolved on time.

However, there could be unintended consequences if the policies lack flexibility and result in abrupt tightening of liquidity, potentially leading to isolated LGFV defaults.

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