Moody’s cuts outlook on China government credit to ‘negative’

Clifford Coonan in Beijing

Moody’s, the ratings agency, has cut its outlook on China’s government credit to ‘negative’ from ‘stable’ on the back of a growing debt burden in the world’s second largest economy, and the challenges of reform.

In a report issued days before China’s leaders gather to approve the latest Five-Year Plan for the economy at the National People’s Congress, Moody’s uncertainty about Beijing’s capacity to implement widescale reforms to address imbalances in the economy.

“The first driver of the negative outlook on China’s rating relates to the government’s fiscal strength which has weakened and which we expect to diminish further, albeit from very high levels,” Moody Investors Service said in a statement.

China is faced with drastic reform challenges as the economy seeks to cut bloated state-owned enterprises and move manufacturing industry up the value chain and encourage more innovation. It also needs to cut debt levels running at nearly 250 per cent of GDP, by some measures, and try and shore up the capital leaving the country at an unprecedented rate.

At the same time, it needs to ensure political stability and quell any threats to the rule of the Communist Party.

The annual parliament, the National People’s Congress, kicks off on Saturday and economic challenges will top the agenda as the government aims to meet goal of doubling per-capita income by 2020.

Moody’s may downgrade China’s rating if the pace of reform flags, but said it would revise the outlook to stable if the nation reduces its liabilities by restructuring state-owned enterprises.

Yin Weimin, the minister for human resources and social security, said this week that 1.3 million workers in the coal sector could lose jobs, plus 500,000 from the steel sector. China’s coal and steel sectors employ about 12 million workers.

Beijing is allocating 100 billion yuan (€14 billion) over two years to relocate workers laid off as a result of China’s efforts to curb overcapacity.

Also this week, the People's Bank of China made a 50 basis point cut in the reserve requirement ratio (RRR) for Chinese banks. The curt in the RRR, combined with record loan growth in January, prompted the ratings agency Fitch to warn against the prospect of more credit-driven growth.

“Rolling over more debt will only delay and not resolve an expected rise in non-performing loans,” Fitch analysts wrote.

As the economy readjusts, China reported economic growth of 6.9 per cent for 2015, its weakest in 25 years. This remains a healthy rate and there is a general tone warning against too downbeat a picture of the Chinese economy.

With this in mind, Moody’s reaffirmed China’s Aa3 rating, saying the scale of the Chinese economy contributed to its credit strength.

“Moreover, although GDP growth is slowing, it will remain markedly higher than most of China’s rating peers. The size of the buffers available to face current fiscal and capital outflow challenges allows for a gradual implementation of reform and therefore supports an affirmation of the rating at Aa3," Moody’s said.

“These buffers include a relatively moderate level of government debt, which is financed at low cost, and high domestic savings and still substantial foreign exchange reserves,” it wrote.

For Irish companies operating in China, the environment remains very positive and Stan McCarthy, CEO of Ireland's largest food firm Kerry Group, said the company remained as optimistic as ever about China and Asia despite the negative headlines.

Infant formula has been central to Irish export growth to China, and exports of specialist nutrition powders from Ireland jumped by 40 per cent in China last year. Ireland is now the second largest exporter of infant formula to the fast-growing Chinese market after the Netherlands, having leapfrogged New Zealand last year.

Wyeth, Abbott, Danone and Kerry are all significant Irish players in the infant formula business.