Moody’s downgrades China’s rating for first time in nearly 30 years, changes outlook to “stable”

China’s sovereign rating was cut today by Moody’s to A1 from Aa3. Moody’s also changed its outlook to “stable”. This is Moody’s first downgrade of China in almost 30 years. Moody’s is concerned about the country’s rising government debt and increasing contingent liabilities for the government, particularly as potential growth is decelerating. China’s policy-makers’ obsession with high growth signifies that official growth targets are expected to surpass the economy’s growth potential, and consequently growth would be increasingly dependent on rising leverage.

But, Moody’s has also noted that a stable outlook for the rating suggests that rating risks are balanced. Growth is expected to stay high, while policy support is expected to remain significant and the capital account is still largely closed. Therefore, the downgrade is not a warning of an imminent debt crisis; however, a reflection of a gradual slowdown in credit strength that warrants a lower rating, noted Nordea Bank in a research report.

Today’s Moody’s decision raises the risk that S&P would follow suit with a similar downgrade. Both the rating agencies changed rating outlooks to “negative” in March 2016. Fitch had already downgraded in 2013.

The general risk sentiment might deteriorate slightly as focus returns to China’s economic and financial challenges; however, no outright sell-off of Chinese assets are expected on the back of today’s move, according to Nordea Bank.

According to Moody’s, leverage is expected to continue to increase despite the reforms, owing to the Chinese policy-makers’ obsession with high growth. Furthermore, if monetary policy is focused on averting capital outflows, then fiscal policy would have to bear the burden of keeping up growth that suggests increasing debt.

China’s potential growth is expected to decline to about 5 percent in the next five years, stated Moody. The official growth target is likely to be higher and therefore additional stimuli would be required. According to Moody’s government debt is expected to rise to 45 percent of GDP by the end of the decade. Economy-wide debt is also likely to rise from 256 percent of GDP recorded at the end of last year.