Moody’s Says China’s Real Estate Downturn to Be Manageable

Credit rating agency Moody’s this week predicted that, even if China’s troubled real estate sector should take a turn for the worse, that the impact on the country’s broader economy should remain manageable.

“Our scenario analysis suggests that a deeper property downturn than currently anticipated could shave between 1.5 and 2 percentage points off China’s GDP growth in the absence of an off-setting policy response,” says Michael Taylor, a Moody’s Managing Director.

“However, we expect that the Chinese government would respond to a growth slowdown of that magnitude, and we estimate that it has the policy space to do so without the sovereign rating coming under pressure,” adds Taylor.

Taylor was speaking on the release of a Moody’s report, titled “A Property Downturn in China Would Exert A Marked, But Manageable Economic Impact”. The report was authored by Taylor and other Moody’s senior analysts.

Moody’s current baseline scenario assumes a modest slowdown in the property sector with GDP growth in the 6.5-7.5% range, consistent with the stable outlook Moody’s maintains on the sovereign and most of its rated portfolio.

Noting that the risks to Moody’s forecast for the property sector are skewed to the downside, and that Moody’s has a negative outlook on the sector as a whole, the report attempts to estimate the possible economic and credit effects of a property downturn which is deeper than expected.

In this context, Moody’s developed two scenarios:

(1) property sales volumes fall by 10% this year and next, a level of decline seen in previous property slowdowns;

(2) the fall in transactions combines with a 10% fall in property prices, an event which is not typical of previous property downturns.

Moody’s also predicted that, after noting that household indebtedness is relatively low, and that its rated banks exhibit high capitalization and low non-performing loan (NPL) ratios, and are also likely to enjoy substantial government support, if needed, that neither the household nor banking sectors would magnify the economic impact of a property downturn.

Instead, property sector weakness is likely to spread to the rest of the economy through supply chain linkages, including the construction, metals and machinery sectors, which would be credit negative for these sectors. The report says that these supply chain effects would be large enough to shave between 1.5 and 2 percentage points off China’s economic growth under the two scenarios.

Should either of the scenarios for the property sector threaten to materialize, Moody’s expects that the central government would respond with a stimulus package to off-set the potential decline in GDP growth.

Moody’s estimates that the impact of lower growth and a fiscal stimulus package aimed at containing the slowdown in economic growth to 5.5%-6% would only raise the central government’s debt from 16% to 19% of GDP. The sovereign rating would remain resilient to an increase in government debt of this magnitude.

A downturn in property transactions would also negatively affect the finances of local governments, which rely to a large extent on land sales as a source of revenue.

In the event that the central government would need to bail out some local government financing vehicles (LGFVs), Moody’s estimates that every 10% of LGFV debt that needs such assistance would only amount to a little over 1% of GDP.

Moody’s acknowledges the report’s estimates contain a margin of error. In particular, the implications of the banking system’s reliance on property as collateral and the interrelation between property and shadow banks are uncertain and could result in larger economic effects than are currently captured in our scenarios.