As the country continues its lockdown well into 2023 while consumer consumption slows, China’s economic challenges have become important drivers for internet companies’ credit profiles; dampening industry profitability and cash generation in the short term.
According to the findings of Fitch Ratings, China’s internet companies, including its fintech community, now face a diminishing threat of regulatory risk, bolstered by the attention of the country’s policymakers trying to support the economy. Yet in the aftermath of last year’s policy tightening, some companies may continue to encounter difficulties.
The American credit agency has predicted that China’s economic growth will fall to just 3.7 per cent this year, down from an 8.1 per cent expansion in 2021; a prediction that reflects the impact of lockdowns.
The recovery in activity is likely to be restrained and subject to setbacks, given that the government’s zero-Covid policy is set to remain in place well into 2023, with a high risk of new lockdowns if outbreaks re-emerge.
Although lockdowns can lead to some spending shifting to online firms, weaker economic growth will weigh on overall market growth.
Thus, even though the credit agency expects the market share of online retail to rise to 29 per cent of total retail in 2022, it only predicts a single-figure rise in revenue; slower than both years previous.
It puts forward that the strength of the recovery in consumption, expected in the second half of this year, will be affected by various structural changes, including price sensitivity among consumers amid macro-economic uncertainties and decreasing demand for specific non-essential goods and services.
Many Chinese internet companies have now realigned their strategic focus towards optimising costs, rationalising non-core businesses and pursuing more prudent mergers, acquisitions and investments.
According to the company, these adjustments should help reduce pressure on profitability and cash generation and preserve liquidity and financial flexibility.
There is also a risk that some Chinese internet firms could respond to the difficult demand environment by expanding into new business areas to drive sales. For example, the apparel brand JD has considered launching online food deliveries, which would pitch it against the sector’s dominant players such as Meituan and Alibaba Group, which both have a rating of BBB-/negative and A+/stable respectively.
Increased competition could put downward pressure on ratings for a number of internet companies, but some, such as Meituan, have less headroom than others at their current rating level.
The agency recommends that it would be premature to say whether or not the more conciliatory comments of the government to feature over the past few months mark a sustained alleviation of regulatory pressure on China’s large internet companies.
However, it also emphasises how recent developments, including the resumption of issuing monetisation licences for specific online games, the potential conclusion of an investigation into rideshare firm Didi and the government’s approval of a plan for ‘healthy’ development of the payment and fintech sectors, might mark the loosening of its grip.
Still, the agency retains its belief that regulatory risk will recede as a sector credit concern relative to macroeconomic factors.
Risks to the creditworthiness of specific companies will decrease as they are released from or deal with regulatory challenges, allowing them to focus more on core business challenges and growth.
However, the repercussions of previous regulatory actions will continue to be felt and regulatory risk will remain an important consideration for Chinese internet businesses’ ratings, regardless of potentially positive developments over the next few months.