Coverage: Moody’s cuts its rating of China

Moody’s Investors Services downgraded China’s long-term local and foreign currency issuer ratings on Wednesday, citing expectations that the financial strength of the world’s second-biggest economy would erode in the coming years.

John Ruwitch of Reuters has the news:

The downgrade by one notch to an A1 rating from Aa3 comes as the Chinese government grapples with the challenges of slowing economic growth and rising financial risks stemming from soaring debt.

“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,” Moody’s said in a statement.

“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,” it said.

The ratings agency also changed its outlook for China to stable from negative.

China’s top leadership has 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.

Leslie Shaffer of CNBC.com reported that China’s economic growth is expected to slow to 5 percent:

Marie Diron, senior vice president for Moody’s soverign rating group, told CNBC’s “Street Signs” on Wednesday that the catalyst for the downgrade was a combination of factors, including expectations that potential growth would fall to 5 percent by the end of the decade.

“Official growth targets are also moving down, but probably more slowly. So the economy is increasingly reliant on policy stimulus,” she said, adding that was likely to spur increasing debt levels for the government.

“It’s really the size of the leverage, the trends in leverage as well as the debt servicing capacities of the institutions that have that debt. When growth slows, then that points toward slower revenue growth, probably slower profitability and somewhat weaker debt servicing capacity,” she added.

Foreign-exchange markets reacted to the news, with the Australian dollar dropping from levels around $0.7480 to as low as $0.7452 in the wake of the announcement. China is among Australia’s largest export markets.

But China’s yuan didn’t react much, with the dollar fetching 6.8940 yuan at 9:38 a.m. HK/SIN, compared with Tuesday’s close of 6.8890 yuan.

Kana Nishizawa of Bloomberg News reported that Chinese stocks and its currency both fell:

The Shanghai Composite Index declined 0.8 percent at 10:17 a.m. local time, poised for its biggest loss in two weeks. The yuan dropped 0.1 percent against the dollar, and the cost of insuring five-year sovereign debt from nonpayment rose 3 basis points.

The Moody’s downgrade to A1 from Aa3 comes as local investors desert the equity and bond markets amid a government campaign to cut risk in the financial sector. The Shanghai gauge is the world’s worst-performing major benchmark index this quarter, sliding 6 percent. The yield on China’s 10-year government debt is at 3.68 percent, close to a two-year high.

Chinese stocks are facing a “bigger challenge” than the Moody’s downgrade, said Hao Hong, Hong Kong-based chief strategist at Bocom International Holdings Co. “As the market wobbles, many of the stocks used for pledged loans are nearing the level that could trigger margin calls. This is probably a bigger risk near term. So together with this rating downgrade, it is negative for the market – but not just the downgrade itself.”

Moody’s cited the likelihood of a “material rise” in economy-wide debt and the burden that will place on the state’s finances. Total outstanding credit climbed to about 260 percent of GDP by the end of 2016, up from 160 percent in 2008, according to Bloomberg Intelligence.