Moody’s cuts China outlook, cites reform and fiscal risks

Moody's Investors Service lowered the outlook on China's credit rating from stable to negative, citing a weakening of fiscal metrics and a continuing fall in foreign exchange reserves. The rating agency also noted uncertainty over the capacity of authorities to implement the reforms needed to address imbalances in the world's second-largest economy. China's local and foreign-currency bond and deposit ceilings remain at Aa3.

Moody's noted that government debt had risen from 32.5 percent of gross domestic product (GDP) in 2012 to 40.6 percent at the end of 2015. Moody's forecasts the metric to rise further to 43 percent of GDP by 2017 as Beijing spends more to revive growth that has slowed to the lowest in over two decades. "While not our base case scenario, the government's fiscal strength would be exposed to additional weakening if underlying growth, excluding policy-supported economic activity, remained weak," Moody's said. 

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. At the same time, reserves remain ample, particularly in relation to the size of China's external debt. However, remarks Moody's, 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.

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% may slow planned reforms.