Chinese firms are adapting quickly to trade restrictions abroad and slowing consumption at home, and other Asia countries stand to benefit. This is according to panelists at S&P Global Ratings' recent "China Credit Spotlight" conference.

Trade bans won't affect China's growth much, given they are narrowly targeted, and firms are adopting workarounds. This, along with slowing growth in China, is driving Chinese firms to go overseas, panelists said.

Foreign direct investment (FDI) from China to Southeast Asia now totals about US$20 billion a year, and is still rising. These flows can support sovereign ratings by improving recipient countries' external balance sheets and the skills, income, and productivity of their workers.

The conference, held on Sept. 24, 2024, also saw panelists debate the effectiveness of China's targeted stimulus. Some said measures have not meaningfully boosted consumption. Others argued that the push in semiconductors and electric vehicles (EVs) has led to gains for some provinces and losses for others.

Market watchers are anticipating more measures to come from the National People's Congress in November. Discussions at our conference shed light on what options policymakers still have. Issues discussed include:

• Can targeted stimulus help firms offset pressures from trade restrictions and slowing growth?
• How are Chinese firms in the consumer and tech sectors adapting?
• Will more tariffs send more Chinese firms overseas?
• Is slowing growth also driving Chinese firms to go overseas? If so, where?
• How will the entry of more Chinese firms affect countries' sovereign ratings?
• When will global bond issuance from China recover? Is this a structural problem?

Table 1

Can targeted stimulus help firms offset pressures from trade restrictions and slowing growth?

Nick Marro (EIU):  Trade restrictions are unlikely to significantly affect China's growth. They are difficult to implement because firms always find loopholes and workarounds. One example is Huawei's seven nanometer (nm) phone, which launched in September last year. That said, China's domestic demand is weak, so it relies more on external markets to fuel growth.

On targeted stimulus, it's important to consider not just policies but also regions. China is not one giant monolith. It is a diverse group of regional economies. We can see this in their performance. Economies along the coast are doing relatively well, those in the northeast are under pressure, and those in the central region are emerging stars.

This is because different regions have different industry strengths and structural deficiencies, and will fare differently under various headwinds and policies, whether it's the housing markets or energy transition. For example, EV transition is taking off in Shenzhen and Xi'an but struggling in the industrial Northeast, China's traditional auto hub.

This suggests that policy support may worsen imbalances among regions. Homogeneous competition can arise if every province tries to become a production base for targeted sectors such as chips and electric vehicles. We have seen this trend over the past decade, and it is increasingly raising questions about whether these programs are allocating resources efficiently.

At the corporate level, stronger firms in better positioned regions may benefit more, while weaker firms in less well positioned regions may not survive despite strong policy support. For example, Shenzhen-based Huawei survived direct U.S. restrictions, while Wuhan-based Hongxin went bankrupt in 2021, followed by some 11,000 bankruptcies among chip firms last year despite a lot of funds being dedicated to the industry.

Chart 1

How are Chinese firms in the consumer and tech sectors adapting?

Sandy Lim (S&PGR):  Retail growth will be slower than GDP growth this year, and it will be even slower next year. Sentiment is not picking up meaningfully despite the stimulus, as weak property markets and wage outlooks are eating into the willingness to spend.

Last year, consumers were unwilling to spend on big items such as autos and property, but were willing to spend on small luxury items such as better electronics and premium ice cream and milk. Now, even these pockets of strength are vanishing as consumers trade down across multiple categories.

As a result, all sectors are increasingly tough. Those that are doing better, such as catering and food delivery, are seeing downside risks building. Those that are doing worse, such as auto retailing, are seeing shrinking market value, where volume is picking up slowly but average selling prices are falling faster.

To counter this, some firms are launching cheaper products. This may not necessarily reduce margins since they could make the packaging smaller or cut costs to pass on the savings. Some firms are trying to latch on to consumer trends or to ensure they have the right channel exposure. Tea, coffee, and niche apparel categories have seen double-digit sales growth. The members-only supermarket channel is an interesting category that is posting strong growth despite weakness in the entire supermarket channel.

The risk is that if consumers continue to demand lower prices as well as better functionality, such preferences may become habits, which will make them even harder to reverse.

Clifford Kurz (S&PGR):  In tech, most trade restrictions are incremental and do not affect China's existing chip production. For example, September's update of components and equipment restrictions by the U.S. Bureau of Industry Security targeted quantum computing and other advanced chips, which are not manufactured in commercial volumes in China.

So far, these measures had limited impact, particularly since the sector is benefiting from a demand recovery in smartphones and laptops, with some help from AI. On the supply side, we are starting to see more reliance on domestic suppliers. For example, internet firms are buying AI processors that are made and designed in China from domestic chip producers, which are also increasingly looking to procure equipment domestically.

The restrictions are likely to further emphasize the importance of technology self-sufficiency in China and reinforce the need to aggressively expand chip production capacity. In the first half of 2024, China bought more than US$24.7 billion of semiconductor equipment--more than the U.S., Japan, South Korea and Taiwan combined. Most of the capacity additions are in the more mature process nodes, such as 14nm and above.

On the other hand, reducing dependencies on Western suppliers could be challenging, given some key domestic technology products still trail western counterparts in technology or quality. For example, Chinese smartphone and PC makers still rely on Western chipmakers for central processing units, graphics processing units, and certain software.

On key risks, global overcapacity in chips and components is an obvious one, since multiple countries across Asia, Europe and North America are all looking to expand production. Other key risks include, for China internet firms, falling behind in AI advancement.

Chart 2

Will more tariffs drive more Chinese firms to go overseas?

Clifford Kurz (S&PGR):  We are already seeing supply chains shift due to tariffs and geopolitics. Downstream firms are the first movers, since they are relatively asset-light and rely on less-skilled labor. Hon Hai Precision Industry Co. Ltd., for example, is building more capacity outside China as more of its customers request diversification away from the country.

Midstream component makers may be next. They are more asset-heavy, need more skilled labor, and prefer proximity to suppliers and customers, making it harder and more costly to shift capacity elsewhere. Benefits of such shifts include mitigating their own supply disruption risks and helping end customers to mitigate geographic risks by moving production outside of China.

Nick Marro (EIU):  Tariffs are indeed motivating some firms to go overseas. In Southeast Asia, for example, we noticed that Vietnam's and Thailand's trade deficits with China matched almost perfectly with their trade surpluses with the U.S., indicating transshipment. The U.S. is increasingly aware of this, and will likely take more actions, such as the recent move to scrutinize solar panel supply chains in Malaysia, Thailand, Cambodia and Laos.

These moves reflect supply chain reorganization rather than bifurcation. China still plays an integral role, particularly in upstream and midstream components, even as downstream production grows in Asean and India. Some firms may be considering diversifying new investment to outside China, but very few are aiming to pull out of the country altogether.

There is also growing interest to go back. When we talked to manufacturers, many initially believed they could replicate the China model elsewhere, but more are finding that they can't. Foxconn Industrial Internet Co. Ltd., for example, is reassessing some of its investments in India and going back to China.

This is because China is still a huge end-market, and in manufacturing, procurement, logistics, and talent ecosystems, China is very competitive, and in many ways, unrivaled. As a result, supply chains in the country are very sticky--most are not leaving anytime soon.

Is slowing growth also driving Chinese firms to go overseas? If so, where?

Chang Li (S&PGR):  Weak domestic demand and overinvestment are motivating some Chinese firms, such as construction machinery makers, to go overseas. There is a difference between state-owned (SOEs) and privately owned enterprises (POEs). SOEs tend to focus on traditional, more capital-intensive sectors due to easier access to funding historically. They often go overseas to participate in government-led projects. This is less the case for POEs, which tend to focus on expanding their own sales and production.

Joyce Bing (Abrdn):  SOEs' overseas expansion has slowed since the pandemic due to constrained cross-border traveling during COVID and policy guidance on de-risking and deleveraging. In contrast, POEs' overseas investments have grown, particularly in EVs and new-energy sectors. Favorable policy support helped firms in these sectors domestically, which also helps them in going abroad.

That said, they may face fresh financial, operational, political, and regulatory risks as they enter new markets. Success factors include prior overseas experience, local partnerships, strong management, financial flexibility, and robust domestic operations. It is crucial for firms to maintain solid domestic operations as a safety net and to monitor the investment returns when expanding internationally.

Claire Yuan (S&PGR):  With slowing growth at home and rising trade barriers, Chinese auto makers are increasingly going overseas. The competitiveness of their products is rising and the resilience of their supply chains is improving.

In Southeast Asia, Chinese firms are going to markets including Thailand, Malaysia, and Indonesia, drawn by favorable government policies and rich mineral resources. They are also looking at Europe and Latin America. Some of their overseas plants started operations in the past year, and more will start in the next year or two.

Battery makers tend to follow their EV customers overseas to better serve them. Some have set up plants in Europe and are gradually ramping up production. In Southeast Asia, they are partnering with local firms to invest along the supply chain.

Overseas expansion can improve growth and capacity utilization, but it can also raise execution risks such as capital expenditure and operating-cost overrun. Firms are also exposed to changes in government policies, and shifts in local-government attitudes toward investments by Chinese firms. These risks should remain limited, though, as overseas capacity will remain a small part of these firms' total capacity. Investment that follows an asset-light model, such as through joint ventures with local partners, will help to mitigate such risks.

How will the entry of more Chinese firms affect recipient countries' sovereign ratings?

Andrew Wood (S&PGR):  A strong and consistent inflow of foreign direct investment (FDI) supports sovereign ratings through economic, fiscal, and external channels.

FDI inflows deliver long-term benefits such as more productivity, higher GDP per capita, upskilling of labor, and improved wage structures as workers move from traditional or agrarian work to more value-added activity. FDI also supports the recipient countries' external balance sheets through equity inflows, and fiscal performance through tax revenues.

FDI from China to Southeast Asia is rising, driven by key sectors including EVs, tech, consumer electronics, and financial services. Geopolitics remain a key risk, but governments in the region have been able to balance external relations with both China and the U.S.

In Indonesia, the government has sought greater processing capacity of its major mineral ores for over a decade, with a more recent emphasis on EV manufacturing. These policies have aligned well with the objectives of Chinese firms, which invested heavily into and built many of the country's nickel ore smelters.

FDI pledges from China to Thailand rose 70% in the first half of 2024, with an emphasis on investment into the Eastern Economic Corridor. The area has long enjoyed government schemes to support manufacturing. While Thailand historically has focused on and enjoyed strengths in internal combustion engine (ICE) vehicle value chains, it is starting to transition to EVs. Malaysia has also seen an increase in manufacturing FDI from China.

Singapore serves as a financial hub that channels Chinese investments, as well as funds from many other countries, into the region. Prominent Chinese firms increasingly see Singapore as a developed jurisdiction that offers advantages for establishing regional headquarters. We expect these trends to continue despite geopolitical tensions from within or outside Asia.

When will global bond issuance from China recover? Is this a structural problem?

Charles Chang (S&PGR):  No, the drop in global bond issuance from China or Asia in the past few years is not structural in nature. It's largely due to the rapid rate hike cycle in the U.S. and the property bond defaults in China. Issuance from China fell by half in 2022 and by another half last year.

On recovery, this year is the turning point. Year to date, issuance from Asia is 30% higher, and from China, 60% higher compared with last year. This is due to the start of the U.S. rate-cut cycle and the drop in defaults in China since last year. Credit quality is now less an obstacle, given three-quarters of Asian issuers, and more than 80% of Chinese issuers are now rated investment grade.

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