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Slow pace of reforms prompts Moody’s to review China’s economic outlook as ‘negative’

High debt levels in Chine state-owned companies could make the cost of servicing that debt very high.

In its latest outlook which reflects on the fundamentals of the Chinese economy, Moody’s has downgraded the Chinese government’s debt to "negative" from "stable" citing increased uncertainty over the capacity of the Chinese government to implement economic reforms midst falling reserves and rising government debt.

"Without credible and efficient reforms, China's GDP growth would slow more markedly as a high debt burden dampens business investment and demographics turn increasingly unfavourable. Government debt would increase more sharply than we currently expect," said Moody's in a note on Wednesday.

Moody’s has disclosed that it has discussed the state of affairs of the Chinese economy during its meeting on February 9, including its susceptibility to risks as well as the fiscal strength of its institutions and of the country as a whole.

The rating agency has said its decision to downgrade China’s outlook is driven largely by the near continuous decline of its fiscal strength, including the shrinking of its foreign exchange which have retreated by $762 billion over the short span of 18 months.

More significantly, the credibility of China’s policymakers were at risk of being undermined by partial implementation and/or partial reversals of some of their economic reforms.

"Interventions in the equity and foreign exchange markets over the past year suggest that ensuring financial and economic stability is also an objective, but there is considerably uncertainty about policy priorities," said Moody's.

While not totalling writing-off China’s economy, Moody’s has retained its Aa3 rating citing China’s sizeable reserves which essentially buys it some more time to implement its economic reforms.

Moody’s has nonetheless warned that China’s ratings could be further downgraded if the pace of reforms, needed to support the government’s balance sheet and sustainably support its economy, slowed down.

"It's not a worrying sign yet, but rather a negative direction. That's what Moody's is flagging," said Trinh Nguyen, senior economist for emerging Asia at global asset manager Nataxis.

Nguyen went on to add, "But they have room to do this. They have one of the lowest government debt as a share of GDP in comparison to other emerging nations. And most importantly, as China has a current account surplus it can fund its own fiscal expansion."

"There has been a lot of poor credit allocation, with too much credit directed at inefficient state firms and not enough going towards smaller efficient firms," said Moody’s in reference to rising debt levels of state-owned enterprises, which raise the risks of a sharp economic slowdown.

"Ideally, we'd like to see a bigger overhaul of the state sector including a lot more privatization," said Julian Evans-Pritchard, China Economist at Capital Economics in Singapore.

Debashish Mukherjee

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