China’s Ratings Outlook Shifted to Negative by Moody’s on Rising Debt and Capital Outflows

China’s credit-rating outlook has been lowered by Moody’s Investors Service, which cited deteriorating fiscal strength, a rising debt load and an erosion of reserve buffers due to capital outflows.

Moody’s affirmed the government’s Aa3 sovereign-debt rating, while moving the outlook to negative from stable, the credit assessor said on its website. The negative outlook means the agency is more inclined to downgrade the rating than raise it or leave it unchanged.

One of the drivers of the outlook change is ”the government’s fiscal strength which has weakened and which we expect to diminish further, albeit from very high levels,” Moody’s said in the statement. Another driver is ”China’s external vulnerability. China’s foreign exchange reserves have fallen markedly over the last 18 months.”

The fiscal deterioration is a result of rising government liabilities relating to regional and local governments and state-owned enterprises and banks, Moody’s said, adding that underlying economic growth remaining weaker, which is not the company’s main scenario, would weaken the fiscal position further.

Government debt has risen ”markedly,” to 40.6% of gross domestic product (GDP) at the end of 2015, according to the rating company’s calculation, from 32.5% in 2012. Moody’s predicts a further increase to 43.0% by 2017, driven by government policies to raise spending and possibly to lower taxes to boost growth.

Foreign exchange reserves dropped to $3.2 trillion in January 2016, $762 billion below their peak in June 2014, Moody’s said. While they remain ”ample,” Moody’s said, ”their decline 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.”

Moody’s warned against tightening capital controls to shore up reserves, which it said would be damaging for the economy. The ratings company also highlighted a risk of lost credibility for Chinese authorities and said that fiscal and monetary policy support unleashed to achieve the government’s economic growth target of 6.5% may slow planned reforms.

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