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Standard & Poor’s Ratings Services has revised the outlook on the People’s Republic of China’s ‘BBB’ long-term foreign currency sovereign credit ratings to positive from stable to reflect the progress on structural reform in the world’s sixth-largest economy. At the same time, the ‘A-3’ short-term foreign currency rating on

  • China was affirmed.

    “The outlook revision reflects growing progress on structural reform that is rapidly laying the foundations of a more market-oriented economy less reliant on government spending to maintain GDP growth,” says Joydeep Mukherji, director at Standard & Poor’s Sovereign Ratings Group. “Moreover, the recent change of formal government leadership augurs well for an accelerating pace of reform, including in state-owned enterprises (SOEs) and the financial sector.”

    The rapid growth of the non-state sector in the Chinese economy in recent years makes it easier for government to reduce policy lending directed at SOEs through the financial system, which is already burdened with a high level of nonperforming loans (NPLs). That, in turn, could facilitate a shift toward a less costly strategy for economic growth by staunching the flow of new NPLs, thereby containing the growth of contingent liabilities for the sovereign over the medium term.

    “Deeper financial sector reform, along with further progress in widening the government’s tax base and raising the buoyancy of tax revenues, would contain the government’s debt burden over the medium term. That, in combination with continued economic growth and political stability, would raise China’s sovereign rating”, says Mukherji.

    The ratings on China are supported by:

    • Its strong external position, based on a moderate and declining debt and debt service burden. Gross external debt is projected to decline to about 42% of current account receipts, and total debt service, including short-term debt, to consume about 15% of current account receipts in 2003. High foreign exchange reserves, at more than 800% of short-term debt, and a competitive export sector benefiting from record inflows of foreign direct investment should sustain external liquidity.

    • Its strong record of economic reform. Output from China’s rapidly growing non-state sector (including agriculture) already exceeds one-half of GDP. Falling trade barriers and more liberal rules for foreign investment over the coming years should continue to improve external competitiveness.

    The ratings are constrained by:

    • Growing contingent liabilities in the financial system. NPLs are likely to be just shy of one-half of total lending at the year-end 2002, excluding loans already sold to four asset management companies (AMCs). Based on a modest recovery value of 15% on the NPLs, the cost of recapitalizing the financial system could raise general government debt above 80% of current GDP.

    • The challenge of building new institutions to govern an increasingly affluent and pluralistic market-oriented economy. The sustainability of growth depends on the ability of China’s new leadership to manage the strains of rapid economic modernisation and social dislocation within an institutional structure increasingly at odds with domestic economic and social trends.