Is it China's turn for a downgrade?

Is China due for a credit downgrade? That question arose this week after Fitch Ratings warned that it might cut China’s local-currency debt rating on worries of rising defaults after a lending spree.

But some strategists argue that China is in a relatively good position. According to Andy Rothman, China macro strategist at CLSA, the government has plenty of fiscal firepower to help it withstand a potential global recession, despite a huge amount of spending during the stimulus in 2009.

“The overall level of Chinese government debt hasn’t gone up that much. I believe there’s very little constraint on the Chinese government’s fiscal capacity. Even if another short-term stimulus is needed, they have the capacity to do that,” he said.

Overall Chinese government revenue was up by 31% during the first half of this year after an increase of 21% last year. While the country’s fiscal deficit was about 2% of GDP last year, its fiscal revenue-to-GDP ratio was 21%, up from 14% a decade ago. The Rmb8 trillion ($1.2 trillion) of revenue last year compared with Rmb1 trillion a decade ago, according to CLSA, a Hong Kong-based brokerage.

“There is no such thing as local government debt,” Rothman told reporters in a telephone conference yesterday. “All the local government debt is, in the end, backed by the central government, unlike the situation in the US. And the Communist Party is the most liquid financial institution in the world.” He predicted that China’s economy will grow by 9.5% this year.

Fitch’s current rating for China’s renminbi-denominated debt is AA-, four grades down from the top classification. The agency warned that Beijing might need to bail out the banks as defaults rise among local governments and businesses. The firm has estimated that new loans in China will reach Rmb8 trillion in 2011.

Last month, another credit rating agency, Moody’s Investors Service, also warned that bad debts held by local governments in China were a bigger problem than previously estimated.

Rothman reckoned China doesn’t need another fiscal stimulus as its economic growth remains strong and investment, the most important driver of Chinese growth, remains active. Fixed asset investment has been continuing to run at about 25% growth during the past seven years. Investment by private companies grew by more than 30% growth during the first half of this year, even though private businesses have less access to bank credit. That suggests they are generally investing their own money.

Power production, another indicator of the strength of the economy, was up last month by about 12%. That suggests the industrial sector in China is growing at a pace consistent with about 9.5% GDP for 2011, as CLSA earlier forecast.

Industrial profits at larger companies jumped around 20% during the first seven months of this year and, as a result, investment by big industrial firms was up by 32% year-on-year during that period, compared with 25% during the same period last year.

Rothman said exports will give zero contribution to the country’s economy, but the slower exports will not have any effect on GDP — though it will affect employment.

“Unless we see exports slow so dramatically that we see a significant rise in unemployment among migrant workers assembling iPads, microwave ovens or DVD players, I don’t think we will see another stimulus from China this year,” he said.