China downgraded to A1 by Moody's on worsening debt outlook

[HONG KONG] Moody's Investors Service cut its rating on China's debt, in a challenge to the view that the nation's leadership will be able to rein in debt while maintaining the pace of economic growth.

Moody's reduced the rating to A1 from Aa3 and changed the outlook to stable from negative, the company said in a statement on Wednesday. It cited the likelihood of a "material rise" in economy-wide debt and the burden that will place on the state's finances.

The offshore yuan dipped after Moody's downgrade, weakening 0.07 per cent to 6.8850 per dollar as of 9.04am in Shanghai. The Australian dollar fell as much as 0.31 per cent after the announcement about its largest trading partner.

President Xi Jinping and other top leaders are seeking to rein in credit risks in the financial system, while ensuring there's enough lending to keep the economy humming above their target for economic growth of at least 6.5 per cent this year. Total outstanding credit climbed to about 260 per cent of GDP by the end of 2016, up from 160 per cent in 2008, according to Bloomberg Intelligence.

"It is a psychological blow that China will not take kindly to and absolutely speaks to the rising financial pressures in China," said Christopher Balding, an associate professor at the HSBC School of Business at Peking University in Shenzhen. That said, "It doesn't matter much in the grand scheme of things because so much of Chinese debt is held by state or quasi-state actors and minimal amounts are international investors."

DEBT HOLDINGS

Overseas institutions' holdings of onshore bonds dropped to 830 billion yuan (S$168.2 billion) as of the end of March, from 853 billion yuan three months earlier, People's Bank of China data show. That's less than 1.5 per cent of 63.7 trillion yuan of outstanding notes, according to Bloomberg calculations based on the central bank data.

Moody's lowered China's credit-rating outlook to negative from stable in March 2016, citing rising debt, falling currency reserves and an uncertainty over authorities ability to carry out reforms.

About a month later Standard & Poor's also warned that rising local debt was pressuring the nation's rating.

Those warnings were followed by the International Monetary Fund which in October 2016 said China urgently needs a plan to address a build up of corporate debt that is manageable and that the window to address it "closing quickly." Still, Moody's isn't hitting the panic button.

"The stable outlook reflects our assessment that, at the A1 rating level, risks are balanced," Moody's said in the statement on Wednesday. "The erosion in China's credit profile will be gradual and, we expect, eventually contained as reforms deepen. The strengths of its credit profile will allow the sovereign to remain resilient to negative shocks, with GDP growth likely to stay strong compared to other sovereigns, still considerable scope for policy to adapt to support the economy, and a largely closed capital account."

The move may still discomfort China investors in that it highlights the risks to the economy rather than the ability of the government to control them.

"It is not going to come as any great news to the world that China has problems with a huge credit boom that, in the end, is probably going to require government intervention to bear some of the costs," said Richard Jerram, chief economist at Bank of Singapore Ltd.

"In general I think that people are worried about the rapid pace of debt expansion, but re-assured that most is in local currency, so it is more a question of internal transfers, rather than a more abrupt sort of event driven by the capital account."

BLOOMBERG