Moody’s Investors Service has revised its outlook on China’s credit ratings to negative from stable amid concerns about the country’s fiscal future and the prospect of reform.
The New York-based credit rating agency affirmed its current rating (Aa3) on China, but revised the outlook, citing fiscal concerns, such as rising government debt and rising contingent liabilities on the government balance sheet; ongoing policy, currency and growth risks; and uncertainty about the country’s ability to implement reforms to address imbalances in the economy.
Moody’s says that the government’s fiscal strength has weakened, and that it expects it to “diminish further, albeit from very high levels.” Specifically, Moody’s estimates that government debt in China rose to 40.6% of gross domestic product at the end of 2015 from 32.5% in 2012; it also expects debt to rise further to 43% by 2017.
In addition, Moody’s also notes that leverage in the country’s state-owned businesses is high, and rising, which “raises the risk of either a sharp slowdown in economic growth, as debt servicing constrains other spending, or a marked deterioration of bank asset quality.”
Moody’s also points out that China’s external vulnerability has increased as its foreign-exchange reserves have fallen over the past 18 months, which “highlights the possibility that pressure on the exchange rate and weakening confidence in the ability of the authorities to maintain economic growth and implement reforms could fuel further capital outflows.”
Finally, Moody’s says that “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.”
Failing to implement reforms could harm policy-makers’ credibility, Moody’s says, and it would likely also mean that China’s GDP growth slows more abruptly “as a high debt burden dampens business investment and demographics turn increasingly unfavourable. Government debt would increase more sharply than we currently expect.”
Despite these concerns, Moody’s affirmed its rating on China citing the sheer size of its economy, its still-high growth rate and the country’s capacity to accommodate gradual reform.
“These buffers include a relatively moderate level of government debt, which is financed at low cost, and high domestic savings and still substantial foreign-exchange reserves,” Moody’s says.