Key Reasons for the Downgrade

1. Weakening Public Finances: The downgrade is primarily driven by expectations of ongoing deterioration in China's public finances and an alarming increase in public debt, as the nation navigates through a critical economic transition. Analysts predict continued fiscal stimulus efforts to bolster growth amid sluggish domestic demand and heightened global tariffs, which are contributing to deflationary pressures.

2. Persistent Fiscal Deficits: Fitch projects that China's general government deficit will climb to 8.4% of GDP in 2025, up from 6.5% in 2024. This figure is exceptionally high, surpassing the 2.7% median deficit for countries rated 'A'. Since 2020, China’s fiscal deficits have averaged a staggering 6.5% of GDP, doubling the 3% average from 2015 to 2019.

3. Challenges in Revenue Generation: A structural decline in revenue generation is expected to hinder deficit reduction efforts, with forecasts suggesting revenue/GDP will drop to 21.3% in 2025 from 29.0% in 2018. Local and regional governments are particularly feeling the fiscal squeeze, requiring increased transfers from the central government.

Rising Government Debt

Fitch anticipates that China's government debt, combining both central and local government obligations, will escalate sharply, reaching 68.3% of GDP in 2025 and potentially 80% by the end of 2029. This trajectory positions China's debt levels substantially above the 'A' category peer median of 57% of GDP.

The continued rise in debt is expected to taper slightly towards the end of the forecast period, supported by a recovery in nominal GDP growth and gradual fiscal consolidation. However, persistent risks related to high government debt remain, although a low proportion of foreign currency debt and a high domestic savings rate provide some mitigation.

Economic Growth Outlook

Fitch forecasts that China's GDP will grow by 4.4% in 2025, a slight dip from 5.0% in 2024. While fiscal stimulus is critical for economic support, underlying domestic challenges, especially in the property sector, may hold back more robust growth. Consumption is projected to increase, but lingering weak consumer confidence complicates a stable recovery.

Moreover, external factors, including rising tariffs imposed by the U.S. on Chinese goods, pose additional risks to China’s growth trajectory. While China has diversified its export markets since previous tariff escalations, increased tariffs may still dampen the overall economic landscape.

Conclusion: A Delicate Balance Ahead

China's current economic situation presents a complex mix of challenges and opportunities. With a significant reliance on fiscal stimulus and a shift towards consumption-led growth, the nation's ability to navigate these issues effectively remains a focal point for investors and international markets alike. As Fitch's downgrade serves as a wake-up call, stakeholders will be keenly observing China's next moves in fiscal policy, economic reforms, and growth stabilization efforts in the coming years.

Stay tuned as we continue to monitor these developments.