Moody's released a report on China's macroeconomy Tuesday, showing a positive outlook on China's macroeconomy and credit.
The company holds that the significant credit challenges for China lie in its substantial misallocation of resources at the sectoral level, which results in excessive investment and overcapacity in sectors like steel, coal, aluminum and glass, as well as increasing debt, particularly that of state-owned enterprises (SOEs).
The report says that if the Chinese government's measures lead to a reallocation of labour and capital resources that shift credit towards sectors with a higher productivity growth rate, it will support the Chinese government's credit quality by increasing its debt-carrying capacity.
Moody's think that addressing a misallocation of economic and financial resources in China should be at the centre of its current policies.
At the macroeconomic level, the returns on investment have just stopped declining, and stand at much lower levels than a few years ago. Regarding the allocation of financial resources, there is evidence of companies in the private sector who continue to deleverage while the ratio of the SOE liabilities to the GDP is still rising, although at a slower pace than in recent years.
The report noted that the authorities have identified excessive leveraging as a source of risk to the economic, financial and social stability, and taken a number of measures to tighten access to credit. The overall credit growth has slowed down and is now rising at about the same pace as the nominal GDP.
In the corporate sector, the overall debt has levelled off as a proportion of the GDP, breaking the upward trend of the last nine years. Deleveraging, as measured by the debt or liabilities to the GDP, seems to be occurring faster in the private sector than among the SOEs.
The total SOE liabilities continued to rise in 2017, to 121 percent of the GDP, mainly driven by the increasing leverage of the local SOEs.
Meanwhile, the report finds that the pace of shifts between sectors has risen, with signs of them moving into higher value-added areas.
The structural change index for China's economy as a whole has been rising, signaling that economic resources are shifting between sectors.
Evidence on the mix of products in the manufacturing sector indicates that activities increasingly centre on higher value-added industries with a greater growth potential, such as the manufacturing of automobiles and electronic equipment.
However, the report thinks that there is no evidence that this is leading to a higher productivity growth rate as yet, consistent with significant lags between structural change and its impact on productivity.
Besides, Moody's notes that the ongoing reforms should support a further structural change in China's economy.
The report shows that China is investing a significant amount of money in innovation and has a policy objective to shift its economy towards higher productivity sectors, including through the Made in China 2025 programme.
Faster productivity growth would help to make debt levels more sustainable as the shares of borrowing raised in higher value-added and more productive sectors increased. Whether such a positive credit change materializes will only become more evident over a period of several years.