OREANDA-NEWS. Fitch Ratings has affirmed China's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'A+'. The issue ratings on China's senior unsecured foreign and local currency bonds are also affirmed at 'A+'. The Outlooks on the Long-Term IDRs are Stable. The Country Ceiling is affirmed at 'A+' and the Short-Term Foreign Currency IDR at 'F1'.

KEY RATING DRIVERS

China's 'A+' IDRs with Stable Outlook reflect the following key rating drivers:-

- China's macroeconomic performance is strong on almost any comparison. The five-year average growth rate to 2015 of 7.8% is more than double the 'A' median of 3.1% or 'AA' median of 3.2%. However, China's remarkable growth has been accompanied by a build-up of imbalances and vulnerabilities. Fitch expects growth of 6.8% in 2015 and 6.5% in 2016, well below the 10.5% average over 2001-2010, as the economy goes through a period of adjustment and rebalancing. Fitch's base case is for a relatively smooth transition towards a less credit-intensive and more consumption-oriented, if likely slower, growth path. However, the economy's structural weaknesses give rise to various risks to this relatively benign scenario.

- Aggregate indebtedness of the economy rose to 242% of GDP by end-2014 in Fitch's estimate, up from 128% at end-2008. Fitch expects it to rise further in 2015, posing mounting systemic risk. The stand-alone credit profiles of the banks comprising China's system are weaker than is generally the case for countries whose sovereigns are rated in the 'A' range. Fitch believes the reported non-performing loan ratio for commercial banks of 1.25% at end-2014 is probably deeply understated. Risks remain associated with the proliferation of "shadow banking" activity since 2009, despite recent regulatory action to curb it.

- The agency's expectation that the economy's adjustment will be relatively orderly is based partly on an assessment that the authorities' capacity for economic management remains high, given the state-dominated nature of the system. However, there is a risk of a more disruptive and credit-negative adjustment. Fitch's estimate of China's investment/GDP rate in 2014 of 47.9% in 2014 is the fourth-highest of any rated sovereign. The rise in the investment rate from an average 42% over 2002-2008 coincided with a boom in residential real estate construction. The real estate boom began to unwind in 2014 as credit disbursement slowed, a process that almost certainly has much further to go. A sharper slowdown in construction and real estate development that leads to job losses poses a downside risk to China's economy.

- The sovereign's external balance sheet is China's core credit and rating strength. Official foreign reserves of USD3.84trn at end-2014 dwarf government external debt of USD34.2bn at end-September 2014 (latest available). China's ratio of sovereign net foreign assets (SNFA) to GDP, at 41.4% of GDP at end-2014, was far stronger than the 'A' median of 9.3% and the eighth-highest of any Fitch-rated emerging market sovereign.

- The country's external finances overall are a strength. China's net external creditor position of 41.5% of GDP at end-2014 greatly exceeded the 'A' range median of 7.5%, and was the second-strongest in the 'A' category. The country has run an annual current account surplus since 1994. The liquidity ratio is projected at 509% in 2015, well above the 'A' median of 104% and the 'AA' median of 155%. Fitch does not yet view the rise in private sector external debt and greater volatility of capital flows since 2012 as a risk to the sovereign ratings, although these factors do complicate economic policy-making.

- The Chinese central government has low explicit debt. On-balance-sheet gross central government debt was just 16.6% of GDP while fiscal deposits were 5.6% of GDP at end-2014. However, Fitch believes the Chinese central government faces a range of contingent liabilities. In particular, there is still insufficient clarity over the fiscal indebtedness of local governments (LGs). Fitch estimates China's general government debt (including LGs) at 55.2% of GDP at end-2014, above the 'A' range median of 47.9%. The agency acknowledges that further disclosures on LG debts expected during 2015 could reveal a higher or lower figure. Fitch assesses the public finances as a neutral factor in China's credit profile overall.

- The authorities have committed to a range of structural reforms that could lay the foundations for more sustainable growth in future. Deposit interest rate liberalisation (leading to higher rates) could prove a powerful engine for rebalancing by effectively transferring wealth away from more leveraged corporates towards households, which are net savers. The anti-corruption drive may be viewed as a political strategy by the leadership to centralise power, but could also improve resource allocation by reducing graft.

- China's level of income and development remains low for the 'A' peer range, despite years of rapid growth. Governance indicators are weak for the 'A' range according to the World Bank's framework of indicators. Transparency is low for a relatively highly-rated sovereign, in particular with respect to LG debts and bank balance sheets.

RATING SENSITIVITIES

The Stable Outlook reflects Fitch's view that upside and downside risks to the ratings are balanced. The main factors that individually or collectively could lead to rating action are:

Positive:
- Progress on structural reform oriented towards sustainable longer-term growth
- Increasing evidence that the economy was adjusting smoothly
- Greater clarity on the strategy to address the debt problem in the economy, including at LGs

Negative:
- A sharper growth slowdown than currently anticipated, leading to a rise in unemployment and/or a materialisation of risks to financial stability
- A rise in estimated general government indebtedness well above Fitch's current estimate
- A change in policy direction that increased economic imbalances and structural vulnerabilities, thereby increasing the risk of an eventual disorderly adjustment

KEY ASSUMPTIONS

- The ratings assume the global economy evolves broadly in line with the projections in the agency's Global Economic Outlook, and that the eventual rise in US interest rates does not prompt a global systemic crisis in emerging markets
- Recognising China's emergence onto the global stage, the ratings assume the continuation of an open global trade and financial system
- The ratings assume China's domestic social and political stability is broadly maintained and that regional geopolitical risks do not escalate sharply.