The one-notch downgrade, to A1 from Aa3, comes as China, the world’s second-biggest economy, grapples with the challenges of rising financial risks stemming from years of credit-fuelled stimulus.

“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 in a statement, while also changing its outlook for China to stable from negative.

China’s foreign ministry rejected Moody’s assessment.

It said in a statement that the downgrade – the agency’s first for the country since 1989 – overestimated the risks to the economy, underestimated Beijing’s industrial reform and financial strength and was based on “inappropriate methodology”.

Estimates of China’s total non-government debt have risen from the equivalent of 170 percent of annual economic output in 2007 to 260 percent last year.

Over the same period, Chinese economic growth fell from 14.2 percent to 6.7 percent in 2016, though that still was among the world’s strongest. The finance ministry noted the growth rate ticked up to 6.9 percent in the quarter ending in March and said tax revenue rose 11.8 percent in the first four months of the year.

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China’s leaders have identified the containment of financial risks and asset bubbles as a top priority this year.

Beijing is trying to steer the economy to slower, more sustainable growth based on domestic consumption instead of investment and exports. But growth has repeatedly dipped faster than planners wanted, raising the risk of politically dangerous job losses. Beijing has responded by flooding the economy with credit.

“The planned reform program is likely to slow, but not prevent, the rise in leverage,” Moody’s said.

“The importance the authorities attach to maintaining robust growth will result in sustained policy stimulus, given the growing structural impediments to achieving current growth targets. Such stimulus will contribute to rising debt across the economy as a whole.”

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While the downgrade is likely to modestly increase the cost of borrowing for the Chinese government and its state-owned enterprises (SOEs), it remains comfortably within the investment grade rating range.

China’s Shanghai Composite index fell more than one percent in early trade before paring losses, while the yuan currency in the offshore market briefly dipped nearly 0.1 percent against the US dollar after the news.
The Australian dollar, often see as a liquid proxy for China risk, also slipped. DM