China Credit Outlook Cut to Negative From Stable by Moody's

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  • Moody's cites rising debt, falling reserves, reform doubts
  • Communist Party leaders poised to map out five-year plan

Why Moody's Cut China's Rating Outlook

China’s credit-rating outlook was lowered to negative from stable at Moody’s Investors Service, which highlighted the country’s surging debt burden and questioned the government’s ability to enact reforms just days before leaders gather to approve a five-year road map for the economy.

QuickTake China’s Debt Bomb

The government’s financial strength may come under pressure if it takes on liabilities from troubled state-owned companies, while capital outflows have limited policy makers’ scope to stimulate the weakest economy in a quarter century, the ratings company said in a statement on Wednesday. State intervention in equity and foreign-exchange markets has heightened uncertainty about the leadership’s commitment to reform, Moody’s said.

While markets shrugged off the outlook cut on Wednesday, it highlights concern among global investors that the ruling Communist Party will struggle to overhaul Asia’s largest economy at a time when capital is flowing out of the country and debt levels have climbed to an unprecedented 247 percent of gross domestic product. Chinese leaders will begin nearly two weeks of policy meetings on Saturday to map out how to tackle the nation’s economic challenges and meet the government’s goal of doubling per-capita income by 2020.

“The government’s ability to absorb shocks has diminished and we want to signal this in the negative outlook,” Marie Diron, a senior vice president at Moody’s, said in an interview on Bloomberg Television. Authorities “have stepped backward in their reform steps and so that is creating some uncertainty.”

The concerns flagged by Moody’s, which also included the risk of capital outflows and shrinking foreign-exchange reserves, have already manifested themselves in markets over recent months. The cost to insure Chinese government bonds against default for five years has climbed about 38 basis points, or 0.38 percentage point, since mid-November to 134 basis points. That exceeds the cost of credit-default swaps on the Philippines, which has a Moody’s rating five levels below that of China.

Shanghai stocks, meanwhile, have dropped 20 percent this year and the yuan has slipped 0.8 percent in onshore trading against the U.S. dollar. On Wednesday, credit-default swaps were little changed, while the Shanghai Composite Index climbed 4 percent on speculation the government will announce more economic stimulus measures. The yuan rose less than 0.1 percent.

China’s Ministry of Finance sold 20 billion yuan of 10-year bonds at 2.82 percent and the same amount of 1-year notes at 2.15 percent after the Moody’s announcement on Wednesday. The yields were lower than prevailing rates in the secondary market.

“The ratings haven’t been changed, so I expect market reaction to initially be muted,” said Andy Ji, a Singapore-based foreign-exchange strategist and economist at Commonwealth Bank of Australia. “There’s no new information here, just recognition of the issues we’ve known for years.”

No Quick Fix

While Moody’s cut its outlook, the ratings company also highlighted its rationale for affirming China’s long-term credit rating of Aa3, the fourth-highest investment grade. The large size of China’s economy contributes to its credit strength, while growth is still higher there than most of its peers. The country also has a moderate level of low-cost government debt, high domestic savings and substantial foreign-exchange reserves, Moody’s said.

The ratings company said it may downgrade China’s rating if the pace of reforms needed to support growth slows, while it would revise the outlook to stable if the nation reduces its liabilities by restructuring state-owned enterprises.

“China has been moving toward some of the recommended measures that the ratings agencies have put forward, but the pace may not be what they expect,” said Tommy Ong, a managing director for treasury and markets at DBS Hong Kong Ltd. “It’s a long-term process, no quick fix.”

Growth Target

The Moody’s warning comes two weeks after Standard & Poor’s said in an interview with Bloomberg News that rising debt levels in China could pressure the country’s credit rating. A surge in new credit to a record 3.42 trillion yuan ($525 billion) in January, along with the central bank’s decision this week to cut banks’ reserve requirements, have fueled concern that bad debts will rise as the economic slowdown erodes corporate profitability. Equity analysts at HSBC Holdings Plc downgraded their recommendations on China’s biggest banks on Wednesday.

S&P, which has a China rating equivalent to that of Moody’s, declined to comment on Wednesday. Fitch Ratings, which grades China one notch lower, said in a statement that its view balances “China’s still-strong sovereign balance sheet against broader systemic risks and vulnerabilities in the economy” and that signs of diminished confidence in the government’s willingness to implement a clear economic strategy could be negative for the rating.

Markets may be hopeful that the Moody’s cut “will push the Chinese government to do more by way of reforms,” said Vasu Menon, a Singapore-based vice-president for wealth management research at Oversea-Chinese Banking Corp. “However, if other rating agencies follow suit, this could cause investors to turn cautious, not just on China’s currency and financial markets and but also Asian markets too.”

Slower Growth

Premier Li Keqiang is expected to set a lower bar for economic growth at the upcoming National People’s Congress, with a 2016 target expansion range of 6.5 percent to 7 percent, compared with last year’s goal of around 7 percent.

Economists predict policy makers will keep leaning on credit growth to achieve that target, with seven out of 12 forecasters surveyed by Bloomberg last month seeing the debt-to-gross-domestic-product ratio increasing through at least 2019 and four expecting a peak in 2020 or later. Debt will reach 283 percent of GDP, according to the median estimate of eight economists.

Investors will keep a close eye on China’s foreign-exchange reserves and capital outflows in coming months to gauge prospects for the economy, according to Menon. The nation’s currency hoard shrank by $99.5 billion in January to $3.23 trillion, the lowest level since 2012. The central bank has been spending its reserves to shore up the yuan after investors increased bets against the currency at the start of this year.

Moody’s “does not see the country as being in dire straits yet,” Menon said. “Nevertheless, concerns that China will devalue its currency against the U.S. dollar remain a key global uncertainty.”

— With assistance by Saijel Kishan, Jonathan Burgos, Helen Sun, Enda Curran, and Kyoungwha Kim

(Updates with statement from Fitch in 13th paragraph.)
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