Moody’s Outlook Cut Inspires the PBOC to Strengthen Yuan Support via Fixing.

By Maggie On Dec 6, 2023

Moody’s issued a downgrade warning on China’s credit rating on Tuesday, stating that the world’s No. 2 economy would be burdened by the expenses required to rescue local governments and state-owned enterprises and manage its property crisis.

Moody’s Outlook Cut Inspires the PBOC to Strengthen Yuan Support via Fixing. The ‘outlook’ for China’s A1 debt rating was downgraded from “stable” to “negative” by Moody’s in less than a month. The credit rating agency applied the same downgrade to the United States remaining triple-A grade a month later.

Approximately one-third of issuers have been downgraded within eighteen months of receiving a negative rating outlook historically.

The report added that Beijing should likely increase its assistance to state-owned enterprises and debt-ridden local governments that pose “significant downside risks to China’s fiscal, economic, and institutional strength.”

Moody’s additionally pointed to “increased risks related to structurally and persistently lower medium-term economic growth and the ongoing downsizing of the property sector.”

The Finance Ministry of China expressed disappointment with the decision, stating that the economy would recover and that concerns regarding local government debt and the property crisis were under control.

“Moody’s concerns about China’s economic growth prospects, fiscal sustainability, and other aspects are unnecessary,” according to the ministry.

Concerns about growth pushed blue-chip equities to levels not seen in nearly five years, where some investors cited speculation regarding Moody’s statement before its publication.

According to a source with knowledge of the situation, China’s main state-owned banks, which had supported the yuan throughout the day, ceased selling U.S. dollars in response to the news.

The cost of sovereign debt default insurance for China increased to its greatest level since mid-November. Concurrently, the U.S.-listed shares of Alibaba and JD.com, two of the largest Chinese corporations, declined by 1% and 2%, respectively.

“At this time, the real estate crisis and sluggish growth are of greater concern to the markets than the imminent sovereign debt risk,” said Ken Cheung, chief Asian FX strategist at Mizuho Bank in Hong Kong.

Adverse emotions

It was the first rating adjustment by Moody’s to China since 2017, when debt levels were increasing, and the country was downgraded by one notch to A1.

Moody’s reaffirmed China’s A1 rating on Tuesday, observing that the economy retained a significant capacity to absorb shocks. However, the organization projected that the country’s economic growth would decelerate to 4.0% in 2024 and 2025 and 3.8% on average from 2026 to 2030.

Later in a long-awaited global outlook call, S&P Global, Moody’s principal competitor, expressed its greatest concern that “spillovers” from a deterioration in the property crisis could cause China’s gross domestic product growth to “below 3%” in the following year.

It is anticipated that government advisers from China will advocate for additional stimulus measures during the upcoming annual “Central Economic Work Conference,” establishing the agenda for the following fortnight or two.

Analysts assert that China’s A1 rating is sufficiently high in the “investment-grade” range to prevent global funds from being compelled to sell in the event of a downgrade.

The other major global rating agency, Fitch, assigns China an A+ rating equivalent to Moody’s A1, and both maintain stable outlooks.

Facilitating Traction

Most analysts believe China’s growth is on course to meet the government’s target of approximately 5% this year; however, this is in stark contrast to 2022, when COVID-19 severely disrupted activity.

As the worsening housing crisis has stifled momentum, local government debt concerns, declining global growth, and geopolitical tensions, the economy has struggled to recover from the pandemic robustly.

The limited effectiveness of a multitude of policy support measures has increased the pressure on authorities to implement additional stimulus.

“We had been observing China’s intermittent reopening from the pandemic for over three years, and this year marked their official reopening,” said Art Hogan, chief market strategist at B Riley Wealth in New York.

“But the pace at which the economy has recovered from that has been disappointing.”

It is widely acknowledged among analysts that China’s development has slowed following the decade-long period of breakneck expansion. Many consider Beijing’s economic model to need a shift away from excessive dependence on debt-financed investments and towards a greater emphasis on consumer demand.

Pan Gongsheng, the chief of China’s central bank, vowed last week to maintain an accommodating monetary policy supporting the economy. However, he also urged structural reforms to reduce reliance on real estate and infrastructure for growth.

Increasing debt

To stimulate activity, China announced in October its intention to issue 1 trillion yuan ($139.84 billion) in sovereign bonds by the end of the year. It increased the target budget deficit for 2023 from the initial 3% to 3.8% of GDP.

Rating firms have indicated that debt-ridden Chinese municipalities face contingent liability risks due to years of excessive spending, declining returns from land sales, and escalating COVID-19 expenses.

The newest data from the International Monetary Fund (IMF) indicates that in 2022, local government debt in China amounted to 92 trillion yuan ($12.6 trillion), or 76% of the country’s economic output, up from 62.2% in 2019.

According to data from Goldman Sachs, capital outflows from China have also increased, peaking at $75 billion in September, the largest monthly outflow since 2016.