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 The Moody's downgrade comes just days before the National People's
Congress (NPC) is due to vote on China's 13th five year plan, a
closely held development blueprint for the next five years, which
policymakers began formally drafting in 2015.
Analysts will closely scrutinize the NPC's final text for hints on
the likely trajectory of reform and policymakers' thinking on the
appropriate growth strategy for China - key factors highlighted by
Moody's in the report issued on Wednesday.
"Without credible and efficient reforms, China's GDP growth would
slow more markedly as a high debt burden dampens business investment
and demographics turn increasingly unfavorable. Government debt
would increase more sharply than we currently expect," Moody's said.
The agency said its rating committee had discussed China's status at
a meeting on Feb. 9, during which the country's institutional and
fiscal strength, as well as its susceptibility to event risk, were
reviewed.
The agency said the downgrade was driven by expectations that
China's fiscal strength will continue to decline, as well as the
fall in its foreign exchange reserves which have shrunk by $762
billion over the last 18 months.
It also said that policymakers' credibility was at risk of being
undermined by incomplete implementation or partial reversals of some
reforms.
"Interventions in the equity and foreign exchange markets over the
past year suggest that ensuring financial and economic stability is
also an objective, but there is considerably uncertainty about
policy priorities," Moody's said.
Moody's, however, retained China's Aa3 rating, noting the country's
sizeable reserves gave it time to implement reforms and gradually
address economic imbalances.
But the agency warned that it could further downgrade China's rating
if it saw slowing down of reforms needed to support sustainable
growth and to protect the government's balance sheet.
"It's not a worrying sign yet, but rather a negative direction.
That's what Moody's is flagging," said Trinh Nguyen, senior
economist for emerging Asia at global asset manager Nataxis.
"But they (Chinese authorities) have room to do this. They have one
of the lowest government debt as a share of GDP in comparison to
other emerging nations. And most importantly, as China has a current
account surplus it can fund its own fiscal expansion."
Initial market reaction to the outlook change was muted, although
the cost of insuring Chinese government debt against default rose
slightly.
"The drivers – local government debt, capital outflows, falling
reserves and concerns on the progress of reforms – are all well
recognized by investors and a lot of them have arguably already been
priced in," agreed Aida Yah, Senior Emerging Market Asia Economist
at AXA Investment Managers.
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HIGH AND RISING CORPORATE DEBT
A major rationale for downgraded outlook, Moody's said, was the
large stock of contingent sovereign liabilities such as state-owned
corporations' debt, local government debt, and the debt of China's
big "policy" banks - the Agricultural Development Bank of China,
China Development Bank, and the Export-Import Bank of China.
While Moody's put actual government debt at only 40.6 percent of GDP
at end-2015, Standard & Poor's estimated in July that corporate debt
had already risen to 160 percent of GDP in 2014, twice the level in
the United States and up from 120 percent in 2013.
"There has been a lot of poor credit allocation, with too much
credit directed at inefficient state firms and not enough going
towards smaller efficient firms," said Julian Evans-Pritchard, China
Economist at Capital Economics in Singapore.
In a separate note on Wednesday, ratings agency Fitch also
highlighted rising risks to Chinese banks from accelerating credit
growth.
"The 50bp cut to the reserve requirement ratio (RJR) for Chinese
banks on Tuesday, together with record loan growth in January, could
point to an increasing likelihood that the authorities are shifting
policy to enable more credit-fueled growth," Fitch analysts wrote.
"Rolling over more debt will only delay and not resolve an expected
rise in non-performing loans."
On Tuesday, the People's Bank of China cut bank reserve ratio
requirements by 50 basis points, releasing an estimated $100 billion
of cash for lending.
(Reporting by Brenda Goh in Shanghai and Rishika Sadam in Bengaluru;
Additional Reporting by John Ruwitch, Nathaniel Taplin, Michelle
Price, Umesh Desai and Elzio Barreto; Editing by Eric Meijer)
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