Moody’s Downgrades China on Rising Debt Concerns

Moody's Investors Service Wednesday downgraded China's credit ratings for the first time in nearly 30 years. Moody's said it expects the financial strength of the Chinese economy will erode in coming years as growth slows and debt continues to rise.

The one-notch downgrade in long-term local and foreign currency issuer ratings, to A1 from Aa3, comes as China grapples with the challenges of rising financial risks stemming from years of credit-fuelled stimulus, RTE reported.

"The downgrade reflects Moody's expectation that China's financial strength will erode somewhat over the coming years, with economy-wide debt continuing to rise as potential growth slows," the rating agency said. It also changed its outlook for China to stable from negative.

China's Finance Ministry said the downgrade, Moody's first for the country since 1989, overestimated the risks to the economy and was based on "inappropriate methodology".

"Moody's views that China's non-financial debt will rise rapidly and the government would continue to maintain growth via stimulus measures are exaggerating difficulties facing the Chinese economy, and underestimating the Chinese government's ability to deepen supply-side structural reform and appropriately expand aggregate demand," the ministry said.

China's leaders have identified the containment of financial risks and asset bubbles as a top priority this year. All the same, authorities have moved cautiously to avoid knocking economic growth, gingerly raising short-term interest rates while tightening regulatory supervision.

Cost of Borrowing to Rise

At the same time, Beijing's need to deliver on official growth targets is likely to make the economy increasingly reliant on stimulus, Moody's said. "While ongoing progress on reforms is likely to transform the economy and financial system over time, it is not likely to prevent a further material rise in economy-wide debt, and the consequent increase in contingent liabilities for the government," Moody's said.

While the downgrade is likely to modestly increase the cost of borrowing for the Chinese government and its state-owned enterprises, it remains comfortably within the investment grade rating range.

In March 2016, Moody's cut its outlook on China's ratings to negative from stable, citing rising debt and uncertainty about authorities' ability to carry out reforms.

Rival ratings agency Standard & Poor's downgraded its outlook to negative in the same month.

S&P's AA- rating is one notch above both Moody's and Fitch Ratings, leading to speculation among analysts that S&P could also downgrade soon.

Slowing Growth

Moody's has Japan at the same A1 rating China is now on.

Moody's has no specific timetable for re-visiting China's rating, but would monitor conditions on a regular basis, said Marie Diron, associate managing director of Moody's Sovereign Risk Group.

The slowing economy has become an increasingly sensitive topic in China, with authorities directing mainland Chinese economists and journalists towards more positive messaging.

Authorities have stepped up efforts over the last several months to curb debt and housing risks, and a raft of recent data has signaled a cooling in the economy, which grew a solid 6.9% in the first quarter.

China's potential economic growth was likely to slow towards 5% in coming years, but the cool-down is likely to be gradual due to expected fiscal stimulus, Moody's said.

"Our GDP will keep medium and high-level growth and that will provide fundamental support to fend off local government debt risks," China's Finance Ministry said.

"China's government debt risks will not change dramatically in the period of 2018-2020 from 2016," it added.

Government-led stimulus has been a major driver of growth over recent years, but has also been accompanied by runaway credit growth and has created a mountain of debt—now standing at nearly 300% of gross domestic product.

Moody's said it expects the Chinese government's direct debt burden to rise gradually towards 40% of GDP by 2018 "and closer to 45% by the end of the decade".

A growing number of economists believe that a massive bank bailout may be inevitable in China as bad loans mount.