Moody’s Cuts China Credit Outlook to Negative on Rising DebtMoody’s Cuts China Credit Outlook to Negative on Rising Debt

Moody’s Investors Service has revised its outlook for China sovereign bonds to negative, reflecting growing global apprehensions about the extensive debt levels in the world’s second-largest economy. The rating agency adjusted the outlook from stable to negative while maintaining a long-term rating of A1 for China’s sovereign bonds, citing concerns over the country’s use of fiscal stimulus to support local governments and the escalating property downturn.

In response to the rating change, the Chinese government expressed disappointment, asserting that the nation’s economy is highly resilient with significant potential. The finance ministry released a statement affirming that the impact of the property downturn is well-controlled. This shift in Moody’s perspective coincides with China’s response to its deepening property crisis by implementing fiscal stimulus measures, leading to increased borrowing and raising concerns about the nation’s record bond issuance this year.

China’s economy has faced challenges this year, with a weaker-than-expected rebound from Covid Zero policies and a deepening property crisis. Recent data revealing contractions in both manufacturing and services activities in November has strengthened the belief that additional government measures are necessary to support the struggling recovery.

President Xi Jinping emphasized in October that a sharp growth slowdown and lingering deflationary risks would not be tolerated. The government increased the headline budget deficit to 3.8% for 2023, surpassing the longstanding 3% limit, allowing for the sale of 1 trillion yuan in additional sovereign bonds for disaster relief and construction. Local governments also issued special refinancing bonds to address off-balance sheet debt concerns.

Moody’s expressed concerns about the policy challenges posed by local government debt and emphasized the central government’s focus on preventing financial instability. However, maintaining financial market stability while avoiding moral hazard and controlling fiscal costs remains a significant challenge.

Despite Moody’s downgrade, the yuan saw minimal changes in both onshore and overseas trading, and the yield on China’s 10-year government bonds remained steady at 2.68%. The MSCI China Index experienced a 1.7% decline, heading for its lowest close since November 2022. Moody’s had previously downgraded China’s credit rating in 2017, the first such downgrade since 1989, due to concerns about a potential rise in economy-wide debt.

Fitch Ratings Ltd. recently indicated the possibility of reconsidering China’s A+ sovereign credit score, while S&P Global Ratings has maintained China’s A+ rating with a stable outlook since its last downgrade in 2017. Despite the risk of a rating downgrade, analysts believe the impact on bond flows will be limited, especially with the China-US rate spread remaining a key driver.

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