Moody's thumbs down to China's debt outlook

07 Mar '16

3 min read

Moody's Investors Service has lowered the outlook on China's government credit ratings to "negative" from "stable", citing governments' weakening of fiscal metrics and rising contingent liabilities.

The rating agency attributed the change in outlook to three major factors: rising government debt in large and rising contingent liabilities on the government balance sheet; a continuing fall in reserve buffers due to capital outflows; uncertainty about the authorities' capacity to implement reforms to address imbalances in the economy.

The first driver of the negative outlook on China's rating relates to the government's fiscal strength which has weakened and which Moody's expects to diminish further, albeit from very high levels.
The second driver relates to China's external vulnerability. China's foreign exchange reserves have fallen markedly over the last 18 months, to $3.2 trillion in January 2016, $762 billion below their peak in June 2014.

The third driver concerns institutional strength. China's institutions are being tested by the challenges stemming from the multiple policy objectives of maintaining economic growth, implementing reform, and mitigating market volatility. Fiscal and monetary policy support to achieve the government's economic growth target of 6.5 per cent may slow planned reforms, including those related to state-owned enterprises (SOEs).

Moody's said Chinese government debt has risen markedly, to 40.6 per cent of GDP at the end of 2015, from 32.5 per cent in 2012. It expected a further increase to 43 per cent by 2017, given an accommodative fiscal stance. The agency expects debt affordability to remain high as large domestic savings will continue to fund government debt.

Moody's kept the Aa3 rating for Chinese government bonds unchanged, given China's fiscal and foreign exchange reserve buffers remain sizeable.

It provided a silver lining to the negative rating, saying that it could revise the rating outlook to stable if government policy was likely to succeed in balancing competing priorities and thereby arrest the deterioration in China's fiscal metrics and reduce contingent liabilities, most likely through effective restructuring of SOEs in overcapacity sectors.

Conversely, Moody's could downgrade the rating if it observed a slowing pace in the adoption of reforms needed to support sustainable growth and to protect the government's balance sheet. Tangibly, this could happen if debt metrics weaken, contingent liabilities increase, or progress on SOE reform stalls. Sustained capital outflows or a marked tightening in capital controls without tangible progress on reform implementation would also be consistent with a downgrade of the rating, it said. (SH)

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