Fitch cuts China debt outlook to negative citing risks to public finances 

On Wednesday, Fitch Ratings revised its outlook on China's sovereign credit rating from stable to negative, citing increasing risks to the nation's public finances amid increasing economic uncertainty as it attempts to transition to new growth models.  

The adjustment echoes a similar move by Moody's in December, highlighting the challenges Beijing faces in its efforts to spur a sputtering post-pandemic economy of the world's second-largest economy with fiscal and monetary support. 

Gary Ng, Asia-Pacific senior economist at Natixis, commented on the downgrade to Reuters on Wednesday: 

"Fitch’s outlook revision reflects the more challenging situation in China’s public finance regarding the double whammy of decelerating growth and more debt. This does not mean that China will default any time soon, but it is possible to see credit polarization in some LGFVs (local government financing vehicles), especially as provincial governments see weaker fiscal health." 

Chinese economy attempting to find its footing 

Fitch projects a rise in China's combined central and local government debt, expecting it to increase to 61.3% of the gross domestic product (GDP) in 2024, up from 56.1% in 2023 — a clear deterioration from the 38.5% recorded in 2019.  

The agency also anticipates the general government deficit, which covers infrastructure and other fiscal activities beyond the primary budget, to escalate to 7.1% of GDP in 2024 from 5.8% in 2023. This would be the highest deficit since 2020, when stringent COVID-19 restrictions weighed heavily on the Chinese economy. 

Despite lowering its outlook, Fitch maintained China's issuer default rating at 'A+', its third-highest grading, suggesting that a downgrade could occur in the medium term.  

S&P, the other major global ratings agency, assigned China an 'A+' rating, on par with Moody's 'A1' rating. 

The ratings warnings come despite early signs that the Chinese economy is finding its footing. China’s factory output and retail sales exceeded forecasts in January-February, following better-than-expected exports and consumer inflation figures. 

This data has increased Beijing’s hopes that it can achieve what analysts call an ambitious GDP growth target of around 5% for 2024. 

Economic growth in China is forecasted by Fitch to decelerate to 4.5% in 2024 from 5.2% in the previous year, slightly below the International Monetary Fund's projection of 4.6%. 

"The outlook revision reflects increasing risks to China's public finance outlook as the country contends with more uncertain economic prospects amid a transition away from property-reliant growth to what the government views as a more sustainable growth model”, Fitch said. 

"Wide fiscal deficits and rising government debt in recent years have eroded fiscal buffers from a ratings perspective," the agency added. "Contingent liability risks may also be rising, as lower nominal growth exacerbates challenges to managing high economy-wide leverage”. 

Downgrade reflects “fundamental concern” over China’s fiscal health 

In its fiscal strategy, China aims to maintain a budget deficit of 3% of GDP, down from the revised 3.8% last year.  

It also plans to issue 1 trillion yuan ($138.30 billion) in special ultra-long term treasury bonds, which will be excluded from the budget calculations. The quota for special bond issuances by local governments is set at 3.9 trillion yuan, an increase from 3.8 trillion yuan in 2023. 

China's debt-to-GDP ratio escalated to a record 287.8% in 2023, up 13.5 percentage points from the prior year, as reported by the National Institution for Finance and Development (FIND) in January. 

China treasury bond issuance shows Beijing wants to shoulder more of the growth burden 

The decision to issue treasury bonds reflects Beijing's intent to take on a greater portion of the burden of meeting growth targets, as local governments have faced reduced fiscal revenues and declining land sales. 

Dan Wang, chief economist of Hang Seng Bank China, told Reuters: 

"The Fitch revision has reflected the fundamental concern over China’s fiscal health and its ability to drive growth in the long term. With lagging private investment, state-backed funding has become even more important in driving growth, either in terms of infrastructure spending or in local government guidance funds for high tech industries”. 

After the announcement, China’s finance ministry said that it regretted Fitch's ratings decision, vowing to take steps to prevent and resolve risks from local government debt. 

"In the long run, maintaining a moderate deficit size and making good use of valuable debt funds is beneficial for expanding domestic demand, supporting economic growth, and ultimately maintaining good sovereign credit," the ministry said in a statement. 

Moody’s issued a downgrade warning on the China credit rating in December, citing costs to bail out local governments and state firms — and control its property crisis.