Moody’s downgrades China sovereign credit outlook to negative

The agency said today (5 December), that a variety of factors, including persistently lower medium-term economic growth and the ongoing downsizing of the property sector, meant it would be downgrading the country’s outlook.

These economic problems will likely lead to greater government intervention in the economy, it said, as regional and local governments face lower revenue from land sale taxes and therefore are unable to properly invest in state-owned enterprises.

Moody’s said China’s central government will be pushed to provide financial support to local governments and state-owned enterprises, which it said risks crystallising contingent liabilities with greater costs than is consistent with the country’s A1 rating.

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“To offset the diminished role of the property sector over the medium term, substantial and coordinated reforms will be needed for consumption and higher value-added production to drive growth,” it said.

“These trends underscore the increasing risks related to policy effectiveness, including the challenge to design and implement policies that support economic rebalancing while preventing moral hazard and containing the impact on the sovereign’s balance sheet.”

Despite the downgrade, the country’s A1 rating was affirmed by Moody’s, which it said reflected the country’s financial and institutional resources to manage the declining size of the property sector in an “orderly fashion”.

“[China’s] vast size and robust, albeit slowing, potential growth rate, support its high shock-absorption capacity,” the agency explained.

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Moody’s said it now expected China’s annual GDP growth to be 4% in 2024 and 2025, and average 3.8% from 2026 to 2030, with structural factors such as weaker demographics driving a decline in potential growth to 3.5% by 2030.

Vikram Aggarwal, fixed income portfolio manager at Jupiter Asset Management, said that the change was “appropriate”, given that the country’s economy is expected to struggle to generate strong growth over the next few years. 

He said: “The Chinese authorities are deliberately engineering a shift of the economic model away from manufacturing-driven growth, towards domestic consumption and services-driven growth. We also expect the total amount of stimulus used by the Chinese authorities to be lower than in previous economic cycles.

“With regards to the property sector, we expect authorities to intervene only if there are broader systemic risks – the top leadership has repeatedly affirmed that ‘houses are for living, not for speculation’.”

The manager said that this shift would be “very influential for other EM economies – external demand, of which China is a key contributor, will therefore remain weak”.

“Coupled with still tight external financing conditions, we now expect EM assets to underperform in H1 2024,” Vikram said.