China: Downgrade puts focus back on financial risks - Danske Bank

Earlier today Moody’s downgraded China’s rating by one notch. According to analysts from Danske Bank, S&P could follow soon and they expect market focus to return to China’s financial risks this year. 

Key Quotes: 

“Overnight Moody’s downgraded China by one notch from Aa3 to A1 – the first downgrade since 1989. It changed the outlook from negative to stable. The rationale behind the downgrade is rising debt and Moody’s expectation of a  continuing increase in leverage in coming years, which will erode China’s financial strength.”

“Moody’s also highlights that the growth target the government is pursuing in the Five-Year Plan will rely on continued stimulus and rising leverage. ‘Taken together, we expect direct government, indirect and economy-wide debt to continue to rise, signalling an erosion of China’s credit profile, which is best reflected now in an A1 rating.’”

“The move by Moody’s does not seem to relate to the recent bouts of financial stress but is based more on a long-term sustainability analysis. S&P could soon follow, as it now has a one-notch higher rating than both Moody’s and Fitch.

“We expect focus to return to China’s financial risks this year, as growth slows down. We continue to see downside risks to Chinese growth based on the policy tightening already done and the current stress in bond markets. We do not expect a big financial crisis in the short term (next one to two years), as we believe China is likelyto take a step back on regulatory tightening if stress gets too high and threatens the economy ahead of the 19th National Congress of the Communist Party in the autumn.”

“The medium-term risks and structural downside pressure on growth are the main reasons we continue to look for a continued gradual weakening of the CNY versus both the USD and EUR over the coming years and recommend to hedge CNY receivables.”