Despite international pressure, a revaluation of the Chinese yuan is not expected immediately given the negative impact that would have on Chinese exports, Fitch Ratings says.

James McCormack, head of Asia Sovereigns at Fitch, said that despite China’s impressive economic growth record, the main government policy challenge is the need to rebalance the components of its GDP growth.

“The Chinese authorities recognize the need to reduce investment spending, which is exceptionally high, and the importance of having offsetting increases in other components of GDP. This is essential if China wants to avoid a hard landing,” he said.

McCormack added that it is in this context that Fitch assesses the likelihood of an exchange rate revaluation, “Our view is that as long as the authorities are focused on rebalancing the GDP growth mix, a revaluation is less probable since that would be detrimental to net trade.” He went on to say that it is still unclear whether the administrative measures and other policy initiatives that have been introduced to rebalance growth are succeeding, leaving some uncertainty for China’s economic outlook.

Meanwhile, Asian economies will likely face a tougher external environment in the months ahead, in view of weakness in global demand and volatility in the global electronics markets, Fitch cautioned. However, in the second half of 2005, improving business conditions within Southeast Asia and strong domestic demand will help counter global weakness.

“A revival in domestic private demand in Southeast Asia, on the back of low real interest rates, improving business confidence, tightening capacity utilization rates and rising profitability, should mitigate the impact of expected slowdowns in China and the U.S.,” said Ngiam Ai Ling, associate director in the Sovereigns Group in Asia.

Senior members of Fitch’s analytical team speaking at a Beijing conference also added that profits at Chinese banks could ease this year because of slowing lending growth and mounting bad loans. David Marshall, Fitch’s head of Banks and Financial Institutions for Asia, expressed the view that the banking system is on a long-term positive trend, with visible improvements in bank supervision and management. “However, much work remains to be done in the areas of risk management and internal controls as well as in strengthening China’s regulatory and legal institutions.”

This overall trend does not mean they are immune to the effects of the business cycle. Chinese banks have been showing strong profit growth for 2004, reflecting the higher income they are enjoying from the large amount of new lending placed out in 2003. “As lending growth had started to slow from mid-2004, we should see lower profit growth for banks in 2005, with the possibility that profits could even fall if banks need to set aside larger amounts for bad debts,” Marshall added.

Fitch expects Chinese banks to face higher bad debts in the next few years as some of the loans put on the books during the credit boom that peaked in 2003 turn bad. The amount of such bad debts cannot yet be determined but Fitch notes that any bad debt write-off would be a heavy burden for Chinese banks given their modest profitability and weak capital ratios.

Marshall added that if banks underestimate future credit losses they may not keep enough capital to remain adequately capitalized during a downturn. This is the worst time for banks to be facing capital pressures as they may cut back lending, thereby worsening the slump, he noted. “Basel II therefore places a large responsibility on banks to ensure that they are calculating potential credit losses through the cycle. This is hard to do in any economy and in China, which is making the transition from a planned to a market economy, it is especially difficult,” said Marshall.