Moody's downgrades China, expects financial strength to erode as debt rises

Moody's China downgrade would probably not have a much broader spillover impact on global financial markets, said Suan Teck Kin, economist for United Overseas Bank in Singapore, noting that Moody's economic growth estimate seemed "too pessimistic".

The outlook for China was changed from stable to negative.

China is faced with balancing the challenges of slowing economic growth and rising financial risks stemming from soaring debt.

Moody's Investors Services downgraded China's long-term local and foreign currency issuer ratings before China's markets started trading on Wednesday, citing expectations that the country's financial strength would erode in coming years.

In March 2016, Moody's changed its outlook on China's government credit ratings to negative from stable, citing rising debt and uncertainty about the authorities' ability to carry out reforms and address economic imbalances.

The new rating will likely raise borrowing costs, though it is still the fifth highest on Moody's investment grade scale. The offshore yuan extended losses after Moody's downgrade, weakening 0.12 percent to 6.8889 per dollar as of 8:24 Shanghai. The yuan was marginally weaker at 6.8949 per dollar while the Shanghai stock index fell one percent to 3031.39 points. In March of past year, it cut China's outlook to negative from stable. Its AA- rating is one notch above both Moody's and Fitch Ratings' A+ rating.

Moody's said its now stable outlook reflected the assessment that risks were balanced.

The Chinese government is facing the hard balancing act of trying to rein in the country's high levels of corporate debt while keeping the world's second largest economy growing at a steady clip.

The agency said capital formation in China is expected to slow as investments have a lower share in total expenditure. China's massive debt been at the center of concerns among economists and Beijing in recent months, and has rattled global financial markets since late previous year. Moody's said it expects China's economic growth potential to decline to around 5 percent over the next five years because of three reasons.

"The downgrade jolted markets and the Australian dollar again showed itself to be the preferred FX proxy for China's economy", said Sean Callow, a senior currency strategist at Westpac Banking Sydney.

The rating would come under negative pressure if leverage in China was seen to be increasing faster expected, creating tensions in the financial sector, she said.

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