Moody’s downgrades China’s credit outlook for these two reasons

The rating agency Moody’s on Tuesday cut the outlook for the sovereign note of China from stable to negative, in the latest sign of growing global concern about the impact of rising debt of local governments and the worsening of the real estate crisis in the second largest economy in the world.

The rating downgrade reflects growing evidence that authorities will have to provide more financial support to local governments and debt-laden state-owned enterprises, posing broad risks to China’s fiscal, economic and institutional strength, Moody’s said in a statement. a statement.

“The change in outlook also reflects increasing risks related to structurally and persistently lower medium-term economic growth and the ongoing downturn in the real estate sector,” said Moody’s.

Chinese stocks fell to near five-year lows on Tuesday amid concerns about the country’s growth, and rumors of a possible cut by Moody’s dented sentiment during the session, while Hong Kong stocks extended losses.

Major Chinese state banks, which had supported the yuan all day, stepped up dollar sales following Moody’s decision, according to a source familiar with the matter. By late afternoon, the yuan had barely changed.

The cost of insuring sovereign debt China against a default rose to its highest level since mid-November.

Moody’s move was the first change in its view of China since it cut its rating by one notch to A1 in 2017, also citing expectations of slowing growth and rising debt.

Although Moody’s affirmed China’s A1 long-term local and foreign currency issuer ratings on Tuesday, saying the economy still has high shock-absorbing capacity, said it expects the country’s annual GDP growth to slow to 4.0% in 2024 and 2025, and an average of 3.8% from 2026 to 2030.

The downgrade of Moody’s outlook comes ahead of the Central Economic Work Conference, expected in mid-December, at which government advisers call for a stable growth target for 2024 and more stimulus.

Analysts say the A1 rating is high enough in investment grade territory that a downgrade would not trigger fire sales by global funds. The other two major rating agencies, Fitch and Standard & Poor’s, rate China with A+, equivalent to Moody’s. Both have a stable outlook.

The Chinese Ministry of Finance was disappointed by the decision of Moody’s, and added that the economy will maintain its recovery and positive trend. He also stated that real estate and local administration risks are controllable.

“Moody’s concerns about China’s economic growth prospects, fiscal sustainability and other aspects are unnecessary”stated the Ministry.

Fight for traction

Most analysts believe China’s growth is on track to hit the government’s target of around 5% this year, but that compares to a COVID-weakened 2022 and activity is very uneven.

The economy has struggled to mount a strong post-pandemic recovery as a deepening housing market crisis, concerns about local government debt, slowing global growth and geopolitical tensions have sapped momentum.

A number of support measures have been only modestly beneficial, increasing pressure on authorities to deliver more stimulus.

Analysts agree that China’s growth is deviating from the dizzying expansion of recent decades. Many believe Beijing needs to transform its economic model, moving from an over-reliance on debt-driven investment to one more driven by consumer demand.

Last week, Chinese central bank chief Pan Gongsheng pledged to maintain an expansionary monetary policy to support the economy, but also called for structural reforms to reduce dependence on infrastructure and the sreal estate sector for growth.

After years of overinvestment, plummeting profits from land sales and rising costs of fighting COVID, economists say indebted municipalities now pose a serious risk to the economy

Local government debt reached 92 trillion yuan (US$12.6 trillion), or 76% of China’s economic output in 2022, up from 62.2% in 2019, according to the latest data from the International Monetary Fund (IMF).

In October, China unveiled a plan to issue 1 trillion yuan ($139.84 billion) in sovereign bonds before the end of the year to help boost activity, raising the 2023 budget deficit target to 3.8% of gross domestic product ( GDP) from the original 3%.