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May 25, 2017

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China dismisses credit downgrade

CHINA’S Ministry of Finance dismissed yesterday’s decision by Moody’s Investors Service to downgrade the country’s credit rating for the first time in nearly 30 years, saying the ratings agency was exaggerating economic difficulties and underestimating reform efforts.

Moody’s cut China’s rating from Aa3 to A1 while changing its outlook to stable from negative, citing concerns over rising debt and potential growth slowing.

“The downgrade reflects Moody’s expectation that China’s financial strength will erode somewhat over the coming years, with economy-wide debt continuing to rise as potential growth slows,” the agency said.

Moody’s changed its outlook on China from stable to negative in March 2016.

The downgrading came amid a tightened national campaign in recent months to rein in financial risks and an upcoming key political meeting in the fall.

China’s central bank has raised short-term interest rates twice this year, raising the costs for speculators betting against the yuan. The banking regulator, at the same time, has filed several detailed rules since March to crack down on the shadow banking sector to defuse asset bubbles.

“While ongoing progress on reforms is likely to transform the economy and financial system over time, it is not likely to prevent a further material rise in economy-wide debt, and the consequent increase in contingent liabilities for the government,” Moody’s said.

“We expect the government’s direct debt burden to rise gradually toward 40 percent of GDP by 2018 and closer to 45 percent by the end of the decade,” it said.

A ministry statement said the downgrade was based on a pro-cyclical approach which was “not appropriate.”

Procyclical is where governments increase public spending and reduce taxes during a boom, but do the opposite in a recession.

The ministry said the Chinese government’s liability ratio stood at 36.7 percent to GDP by the end of last year, compared to the European Union’s 60 percent and far below the level of other major economies and emerging markets.

It added: “With the pushing of the country’s supply-side reform and the control over government liabilities, alongside a medium and high-level growth of our GDP to provide fundamental support to guard local government debt risks, the risk level of government debt profile won’t significantly change in 2018 to 2020 compared to the year 2016.”

The downgrading will likely modestly increase the cost of borrowing for the Chinese government and its state-owned enterprises. But many analysts believe it will have limited impact on market players, both in onshore and offshore markets.

ANZ said it sees a marginal negative influence from the downgrade on the domestic bond market as local investors are not sensitive to international credit ratings, according to a report released yesterday. And the scenario could be the same in the offshore market.

“Theoretically, Chinese companies that issue offshore dollar bonds could bear more pressure from the downgrade decision,” said Liu Dongliang, a senior analyst at China Merchants Bank Co.

“But buyers of such bonds in most cases are Chinese financial institutions who have closer connections with the issuers, which also makes them less dependent on decisions made by rating agencies.”

The downgrade could also influence the future bond connect program linking foreign investors to China’s nearly US$9 trillion bond market, but the overall impact is expected to be limited, Liu added.

The official onshore yuan traded a little weaker at 6.8909 yuan to the dollar after softening as much as 0.1 percent following the downgrade. Meanwhile, the onshore bond market was muted on the downgrade, with the yield on 10-year Chinese government bonds unchanged at 3.67 percent.

Shanghai shares pulled back from initial sell-offs following the decision, with the Shanghai Composite Index closing 0.07 percent higher, shrugging off a 1.3 percent drop earlier in the day.


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