Downgrade will not burst China's bubble, says analyst

Alicia Cross
May 25, 2017

USA stock futures were marginally higher on Wednesday ahead of minutes from the Federal Reserve's last meeting earlier this month, and after Moody's lowered the credit rating for China, the world's second-largest economy, amid concerns for rising debt levels and slowing growth.

Markets saw an initial sell-off in early Asian trading Wednesday after Moody's Investor Services downgraded China's credit rating one notch to A1 from Aa3, though losses were largely recovered by the close.

In its first downgrade of the country in almost 30 years, Moody's cut China's rating by one notch to A1 from Aa3, saying it expects the economy's financial strength to erode in coming years as growth slows and debt continues to rise.

The Chinese economy expanded by 6.7 per cent in 2016 compared with a peak of 10.6 per cent in 2010.

China's Finance Ministry responded that Moody's had overestimated the risks to the economy and the downgrade was based on "inappropriate methodology".

More broadly, the agency forecasts that economy-wide debt of the government, households and non-financial corporates will continue to rise, from 256% of GDP at the end of previous year according to the Institute of International Finance.

Just over a year ago, Moody's lowered China's credit-rating outlook from stable to negative because of rising debt, falling currency reserves and uncertainty over the government's ability to carry out reforms.

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The ministry also refuted Moody's expectation that China's government debt-to-GDP ratio would rise to 40 percent in 2018.

On Wednesday, after China's sovereign credit rating was seen downgraded, world stocks hit an inched lower. In not adding China a year ago, MSCI cited concerns over share suspension rules and monthly limits on repatriating capital.

Moody's has, however, changed its outlook on China to "stable" from "negative" to reflect its assessment that the risks are balanced at the A1 rating level. With external debt sitting at just 12 percent of GDP, the downgrade may not prove as damaging to China as it would for an economy more reliant on global borrowing.

"The first stage impact is that once the sovereign rating is downgraded, it is likely that most Chinese banks will have to be downgraded as well", Ballard says.

Moody's also claimed that increases in China's local government financing platforms and debt owed by SOEs would lead to rising government contingent liabilities.

As noted by The Wall Street Journal, this latest downgrade will likely increase the cost of borrowing for Chinese firms, with the revision of China's rating likely to have a knock-on effect on the country's banks.

Other reports by Free-Prsite

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