China's emerging current account deficit poses risks

    Moody's Investors Service said in a new report that over the next decade, China's (A1 stable) current account deficit is likely to move into structural deficit, as savings decline more quickly than investment, driven by an aging population and other social trends.
  "We expect China's current account will move into a deficit of around 1.5% of GDP by 2030 from a surplus of around 10% of GDP in 2007. While not our core expectation, the emerging deficit could weigh on the sovereign's credit profile if it occurs faster than we currently expect and/or combines with some capital outflows," said Martin Petch, a Moody's Vice President and Senior Credit Officer.
  Moody's report forms part of an ongoing series of research that provides in-depth analysis on China's contingent liabilities, and the risks posed to financial stability.
  Moody's sees the overall risk to financial stability as low, mitigated by the government's control over the balance sheets of regional governments, banks and state-owned enterprises (SOEs), high savings and a closed capital account. These three factors combine to preserve financial stability amid high economy-wide debt and contingent liability risks from SOEs.
  However, over the medium to long term, Moody's expects that China's rapidly aging population and persistent trade barriers will impair the country's capacity to generate savings large enough to finance economy-wide debt at low and stable costs.
  Unless foreign savings compensate for the shortfall in domestic savings, these trends will gradually undermine one key support to financial stability.
  The credit implications of a structural current account deficit in China will depend on its size and how it is financed. Moody's baseline expectation is for a slow shift into deficit in the context of a closed capital account, with a gradual decline in FX reserves giving the authorities time to adjust policy.
  Moody's also considers alternative, low-probability scenarios that involve a larger-than-expected current account deficit and an opening of the capital account. These scenarios would have potentially significant negative credit implications for the sovereign credit profile.