Moody's cuts China out­look, cites re­form, fis­cal risks

The Pak Banker - - MARKETS/SPORTS -

Moody's down­graded its out­look on Chi­nese govern­ment debt to "neg­a­tive" from "sta­ble" on Wed­nes­day, cit­ing un­cer­tainty over au­thor­i­ties' ca­pac­ity to im­ple­ment eco­nomic re­forms, ris­ing govern­ment debt and fall­ing re­serves.

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 Wed­nes­day.

"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 rec­og­nized 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.

A ma­jor ra­tio­nale for down­graded out­look, Moody's said, was the large stock of con­tin­gent sov­er­eign li­a­bil­i­ties such as sta­te­owned cor­po­ra­tions' debt, lo­cal govern­ment debt, and the debt of China's big "pol­icy" banks - the Agri­cul­tural De­vel­op­ment Bank of China, China De­vel­op­ment Bank, and the Ex­port-Im­port Bank of China.

While Moody's put ac­tual govern­ment debt at only 40.6 per­cent of GDP at end2015, Stan­dard & Poor's es­ti­mated in July that cor­po­rate debt had al­ready risen to 160 per­cent of GDP in 2014, twice the level in the United States and up from 120 per­cent in 2013.

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