Moody’s cuts China outlook on eve of NPC, cites reform, fiscal risks

The Moody’s downgrade comes just days before the National People’s Congress (NPC) is due to vote on China’s 13th five year plan, a closely held development blueprint for the next five years, which policymakers began formally drafting in 2015.

Analysts will closely scrutinize the NPC’s final text for hints on the likely trajectory of reform and policymakers’ thinking on the appropriate growth strategy for China - key factors highlighted by Moody’s in the report issued on March 2.

“Without credible and efficient reforms, China’s GDP growth would slow more markedly as a high debt burden dampens business investment and demographics turn increasingly unfavorable. Government debt would increase more sharply than we currently expect,” Moody’s said.

The agency said its rating committee had discussed China’s status at a meeting on Feb. 9, during which the country’s institutional and fiscal strength, as well as its susceptibility to event risk, were reviewed.

The agency said the downgrade was driven by expectations that China’s fiscal strength will continue to decline, as well as the fall in its foreign exchange reserves which have shrunk by $762 billion over the last 18 months.

It also said that policymakers’ credibility was at risk of being undermined by incomplete implementation or partial reversals of some reforms.

“Interventions in the equity and foreign exchange markets over the past year suggest that ensuring financial and economic stability is also an objective, but there is considerably uncertainty about policy priorities,” Moody’s said.

Moody’s, however, retained China’s Aa3 rating, noting the country’s sizeable reserves gave it time to implement reforms and gradually address economic imbalances.

But the agency warned that it could further downgrade China’s rating if it saw slowing down of reforms needed to support sustainable growth and to protect the government’s balance sheet.

“It’s not a worrying sign yet, but rather a negative direction. That’s what Moody’s is flagging,” said Trinh Nguyen, senior economist for emerging Asia at global asset manager Nataxis.

“But they (Chinese authorities) have room to do this. They have one of the lowest government debt as a share of GDP in comparison to other emerging nations. And most importantly, as China has a current account surplus it can fund its own fiscal expansion.”

Initial market reaction to the outlook change was muted, although the cost of insuring Chinese government debt against default rose slightly.

“The drivers - local government debt, capital outflows, falling reserves and concerns on the progress of reforms - are all well recognised by investors and a lot of them have arguably already been priced in,” agreed Aida Yah, Senior Emerging Market Asia Economist at AXA Investment Managers.