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China’s credit rating cut to A1 by Moody’s, stocks and renminbi fall

China’s credit rating has been downgraded by Moody’s Investor Services on expectations the country’s financial strength will “erode somewhat” over coming years and debt rises, but its outlook was lifted to stable from negative.

That has put Chinese stocks on track for one of their biggest one-day drops this year and has seen the country’s currency weaken in morning trade.

The cut to China’s long-term local currency rating to A1 from Aa3 puts the country on par with Czech Republic, Estonia, Israel, Japan and Saudi Arabia.

China’s A1 rating now puts it one notch below other sovereign borrowers, including Taiwan and Macau, and one notch above the likes of Bermuda, Botswana, Poland and Slovakia.

In justifying its move, Moody’s said China’s potential growth is likely to fall in coming years, making the economy increasingly reliant on policy stimulus. Moody’s continued:

At least over the near term, with monetary policy limited by the risk of fuelling renewed capital outflows, the burden of supporting growth will fall largely on fiscal policy, with spending by government and government-related entities — including policy banks and state-owned enterprises (SOEs) — rising.

Such stimulus will only add to rising debt across the whole economy, the Moody’s warned.

Economy-wide debt is also expected to increase further over coming years, and a planned reform programme will not have “sufficient impact, sufficiently quickly to contain the erosion of credit strength associated with the combination of rising economy-wide leverage and slower growth.”

Moody’s forecasts the government’s direct debt burden to rise gradually to 40 per cent of gross domestic product by 2018 and closer to 45 per cent by the end of the 2020. That is line with the 2016 debt burden for the median of A-rated sovereign borrowers, Moody’s said.

Indirect and contingent liabilities are also expected to rise, with the agency noting the outstanding amount of policy bank loans and bonds issued by local governments rose by a combined 6.2 per cent of 2015 GDP, having gained 5.5 per cent the previous year.

Similar increases in financing and spending by the broader public sector are likely to continue in the next few years in order to maintain GDP growth around the official targets.

In explaining its outlook upgrade to stable, Moody’s said that risks were “balanced” at the A1 level, and that the “erosion in China’s credit profile will be gradual and, we expect, eventually contained as reforms deepen.”

The move brings Moody’s in line with rival agency Fitch, which has had an equivalent A+ rating on China since November 2007. Standard & Poor’s most recently upgraded China’s rating to AA-, which is equivalent to one notch above Moody’s new rating.

The offshore renminbi, the version of the China’s currency that is traded outside the mainland and is not subject to a trading band weakened as much as 0.13 per cent on news of the rating cut, but trimmed losses to be 0.05 per cent softer at Rmb6.8841 per dollar.

The onshore renminbi, which is allowed to trade 2 per cent either side of a daily midpoint, was 0.12 per cent weaker at Rmb6.8937. The renminbi midpoint was set 0.14 per cent softer this morning at Rmb6.8758.

China’s Shanghai Composite was down 1.2 per cent and on track for its biggest one-day drop in a month, and the second-largest fall so far this year. The technology-focused Shenzhen Composite was down 1.7 per cent.