China, downgrade by Moody’s, but the economy remains robust

Moody’s downgraded China’s long-term credit rating last week, after lowering its outlook on the country from stable to negative in March.

As such, the rating downgrade was not a sudden development. This cut takes China’s rating from Aa3 to A1, and the outlook was changed back to stable. It was the first time since 1989 that Moody’s downgraded China.
Explaining the downgrade, Moody’s cited the slow erosion of China’s credit metrics, especially the economy-wide increase in leverage. Structural reform is likely to slow, but not halt, the rise in leverage, according to Moody’s. The move puts China on a par with Japan and Saudi Arabia. Standard & Poor’s has had China on AA- with a negative outlook since March 2016, and Fitch rates China at A+.
The ratings agency also noted that China’s GDP growth is likely to stay strong compared to other sovereigns. The stable outlook reflects their view that the risks are balanced and that a further downgrade is unlikely in the near term.

We believe the impact of the downgrade will be limited and contained. In addition to the Chinese economy’s strengths as acknowledged by Moody’s, China’s external debt (at about 12% of GDP, according to the IMF) remains quite low by international standards. The market reaction so far has also been relatively muted, with the yuan slightly weaker against the US dollar since the news.

China will hold the 19th National Congress this autumn. We expect the government to maintain a stable macroeconomic environment to facilitate a smooth leadership reshuffle. President Xi Jinping has already made significant efforts in expanding domestic consumption and promoting a less credit-intensive form of growth (e.g., through the application of internet and other advanced technologies). The more politically sensitive challenges and other structural reforms to the economy are likely to be addressed after the autumn leadership consolidation.

Leo Hu – Portfolio Manager EMD Hard Currency – NN Investment Partners