Yuan and equity markets fall on Moody’s Ratings downgrade

KEY DEVELOPMENTS

Moody lowered China’s sovereign bond outlook from stable to negative last Tuesday, maintaining its A1 rating. China’s Financial Ministry said it was disappointed with Moody’s assessment, defending China’s long-term economic outlook, saying that it will support positive growth and is controlling its property market and local government debt problems. S&P and Fitch ratings' latest outlooks were both held at A+/stable. Ten-year sovereign Chinese bond yields were unchanged at 2.7%, but the Yuan reversed recent gains to fall almost one percent versus the dollar to USD/CNY 7.1858 from 7.1250. Monday saw Chinese stocks rally strongly.

China recently introduced a one trillion yuan (USD 140 billion) restructuring fund to tackle local government debt, with another one trillion yuan bond targeting infrastructure projects in the last two months. Those ‘pain relief’ bonds increased China’s deficit ratio to 3.8% this year, above the projected 3% planned in March.

Fitch Ratings said China will likely see lower default risks at local government financing vehicles (LGFVs) in 2024, citing a gradual recovery in fiscal revenue and support from the central government. S&P Global (China) Ratings also said the liquidity pressures of LGFVs in economically weak regions will be relieved somewhat next year.

In the real economy, China’s exports, once its economic engine, are under pressure as the US and EU continue to shift their production lines away from China. Chinese exports slightly increased in November despite a sharp decline in EU trade. Chinese imports fell in November, more evidence of sluggish demand.

GLOBAL IMPACT

China’s debt issues in regional and central government and the property and financial sectors are starting to impact financial markets. While Chinese sovereign bonds took the Moody’s rating downgrade in their stride, local equity markets and the Yuan slid after the announcement. The authorities are betting on economic growth to solve various debt issues, with a rosy outlook for 2024. If this fails to materialize, China’s domestic issues will spill over to global financial markets.

MARKETS

• Chinese stock markets sold off last week after Moody’s downgrade, with the Shanghai Composite Index and Shenzhen Composite Index off 2%. Monday saw the indices up 0.7% and 1.0%, respectively.

• The offshore yuan’s four-month rally pulled sharply, with a 0.9% fall versus the dollar, from $/CNH 7.1250 to $/CNH 7.1858. Monday saw the yuan fall further to $/CNH 7.1918.

MAJOR NEWS

Economy

Moody’s downgrades China’s sovereign bonds

• Moody downgraded its outlook on Chinese sovereign bonds from stable to negative, citing downside risks to China’s fiscal sustainability from China’s massive financial support for distressed local government and state-owned enterprises.
• S&P ratings maintained their optimistic outlook for China but noted a possibility of downgrading if China's deficit surges remarkably.
• Fitch Ratings was more positive on China’s financial stress concern, with its director saying that China will likely see lower default risks at local government financing vehicles (LGFVs) in 2024, citing a gradual recovery in fiscal revenue and support from the central government.

China’s central bank will control debt issues

• During an exclusive interview with China's state-run Xinhua News, the governor said that China’s central bank will strictly control new local debt and provide emergency liquidity when necessary to prevent any halt in local operations and broader spread of default risks.
• This positive message reassured the public that the central government could solve local debt problems, most likely by expanding the central government's liability.
• The central government has space to run fiscal stimulus, as its debt ratio was around 21% relative to GDP, a relatively low level compared with other major economies.

China is expected to target 5% economic growth

• China’s central economic work conference, scheduled this month, will see Chinese policymakers discussing financial targets for next year.
• President Xi Jinping’s government is expected to set a longer-term goal of redoubling domestic growth by 2035 from its level in 2020, which means China needs at least 5% annual growth by 2025.
• Market estimates for China’s economic growth next year are lower, at around 4.5-4.8%.

Local government land sale revenue falls sharply

• China's land rights selling revenues were 3.5 trillion yuan ($490 billion) in the first ten months, with another 1.57 trillion yuan ($222 billion) in land-related taxes added to the local government’s revenue, according to the Financial Ministry.
• Total land-related revenue accounted for 35% of total government revenue, at 5.07 trillion yuan ($710 billion), 20.5% lower than last year and notably lower than the proportion of 53% in 2021.
• China’s local governments’ revenue from selling land rights fell 28% year-on-year, with auction land area falling 21.5% year-on-year.
• China’s central government aims to reduce reliance on land finance, and analysts estimate that land-related revenue is expected to shrink to less than 6 trillion yuan ($839 billion) this year.

Exports rise for first time in seven months, but imports disappoint

• China’s exports rose 0.5% year-on-year in November, the first increase in seven months, up from a 6.4% decline in October.
• China’s imports were 0.6% lower year-on-year in November, down from 3.0% in October and well below the market expectation of 3.3%. 
• However, China still lagged behind other Asian export-oriented economies, such as Korea and Vietnam. In November, Korean and Vietnamese exports rose 7.8% and 6.5% year-on-year, respectively.
• China’s shipments to the US rose 7.3% year-on-year in November, compared to an 8.2 % decline in October.
• China’s exports to the EU fell 14.5% year-on-year in November after a 12.6% decline in October.
• China’s exports to Russia surged 33.6% year-on-year in November, up from 17.2% in October.

Commodity imports slump, notably oil

• China’s imports of major commodities slowed in November, with crude oil imports falling 9.2% after a 13.5% fall in October.
• Crude oil imports were up 12.1% year-on-year at 516 million metric tonnes (MMT).
• Natural gas imports slowed to 6.4% year-on-year in November after a 16.0% increase in October.
• Iron ore imports fell 3.9% year-on-year in November after a 4.6% decline in October.
• Coal imports, driven by rising demand in winter use, rose 34.9% in November, after 23.3% in October.

EU-China trade faces challenges.

• Chinese leaders and top EU officials met in Beijing during the 24th China-EU Summit last week to improve trade relations, as disputes between the two sides are common.
• In the first eleven months, China’s exports to the EU have fallen 11% year-on-year.
• The EU is pushing China to use its influence on Russia to stop the war in Ukraine, blaming some Chinese companies’ trade with Russia for undermining the impact of sanctions.
• The EU also stressed the long-existing trade imbalance issue with China and concerns over unfair competition that hurts the EU's businesses and markets.

Chinese regions issue spending vouchers to boost consumption

• More areas in China are reportedly giving vouchers to increase consumers' spending at the year's end, the most crucial holiday season.
• Guangdong launched vouchers worth 100 million yuan ($14.29 million) to encourage spending on travel and hotels, and other cities also issued vouchers to boost sales of automobiles, home appliances, consumer retail products, and catering services.

Private Purchasing Manager’s Index (PMI) optimistic on services rebound

• The private Caixin service PMI rose to 51.5 in November, up from 50.4 in October, suggesting that the service sector expanded faster in November.
• This contrasts with the official services PMI released two weeks ago that suggested service activities unexpectedly contracted for the first time since December last year.
• Caixin's survey focuses more on small to medium-sized businesses in the coastal regions, and its survey results showed both supply and demand of service activities picked up in November. However, employers were cautious about increasing jobs amid high uncertainty about the future.
• Caixin’s PMI data has beaten market expectations in the manufacturing and service sectors, showing encouraging signs of consumer spending, factory operation, and recovering market expectations.

Business

China’s most indebted real estate company allowed to restructure debt

• China Evergrande Group, with liabilities around $327 billion, was allowed to extend its restructuring plan by a court hearing last week.
• This gives the group more than eight weeks to devise a solution to avoid bankruptcy.
• Absent recovering demand to support property sales across the country, the property sector’s debt remains a significant risk for China’s financial system.

Encouraging signs from selected property markets

• Shenzhen City, China’s tech hub, saw the first sign of encouraging housing sales in November.
• New house sales in Shenzhen city were up 4.5% in November, the most significant increase in five months.
• Second-hand house transactions rose 12.9% from October, a steven month high.
• Property sales in China’s first-tier cities, including Guangzhou, Beijing, Shenzhen, and Shanghai, notably improved in November.
• The sales rebound may be supported by newly released demand from those households seeking spacious and higher-quality houses.