Published: Thu, May 25, 2017
Money | By Armando Alvarado

Moody's downgrades China, warns of eroding financial strength as debt rises

"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.

Moody's Investors Service has downgraded the credit rating for China. Private sector analysts say it could drag on the economy or threaten the health of the state-owned banking industry.

Most investors were not taken aback by China's downgrade from an Aa3 credit rating to an A1 on Wednesday, arguing that markets were similarly prepared for such a move.

China's Finance Ministry said the downgrade, Moody's first for the country since 1989, overestimated the risks to the economy and was based on "inappropriate methodology".

Sylvia Sheng, greater China economist at Bank of America Merrill Lynch, believes the slower reading suggests that growth momentum has peaked and will further weaken in the second half as the government continues to siphon off liquidity from the markets.

The Chinese finance ministry criticized the decision.

On the debt front, China's total and private debt is reported to be worth more than 250 per cent of GDP.

Leaders in China have identified containing financial risks and its asset bubbles their top priority in 2017. They have launched initiatives to reduce debts owed by state companies, including by allowing banks to accept stock to repay loans.

The dollar index held steady against a basket of six currencies at 97.321 after bouncing 0.4 percent the previous day.

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Moody's said its now stable outlook reflected the assessment that risks were balanced.

The ministry complained Moody's failed to give enough weight to economic reforms.

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China's growth past year, down from 6.9 per cent in 2015 - the slowest growth since 1990. "Instead, it is that loose credit policies created to prevent struggling firms from failing are eroding the economy's long-run growth potential by preventing resources from being allocated to areas where they could be used more efficiently", said Williams. But growth has repeatedly dipped faster than planners wanted, raising the risk of politically unsafe job losses. Beijing has responded by flooding the economy with credit.

This is likely to make the economy increasingly reliant on policy stimulus, which could in turn exacerbate rising debt levels, it added.

"The reaction has been pretty muted", said Kaan Nazli, senior economist emerging market debt at Neuberger Berman, noting that recent China data had already contributed to a pullback on commodity focused emerging markets.

But the ratings agency saved its most savage criticism for China's inability to allocate capital efficiently and to the areas of the economy which needed it most.

Moody's sees China's growth potentially declining to near 5 per cent over the next five years, even as the government's direct debt burden rises towards 40 per cent of gross domestic product by 2018 from about 14 per cent now.

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