Moody’s move this week to downgrade its outlook on China to ‘negative’ has intensified Beijing’s battle to bolster market confidence.
The news puts pressure on the government to impose more forceful measures to prop up stocks and stabilize the yuan – as the mainland’s blue-chip index, the CSI-300, which tracks stocks in Shanghai and Shenzhen, sank near five-year lows on Wednesday.
In its announcement on Tuesday, the ratings agency flagged weakening growth prospects, adding to mounting global concerns that China’s economic miracle is over, potentially leaving the world’s second-largest economy stuck in a middle-income trap.
While keeping China’s sovereign rating at A1, Moody’s cut its outlook to negative from stable, citing surging municipal debt and property market woes. Such concerns have prompted other institutions to draw comparisons with Japan’s similar macroeconomic symptoms before its “lost decades” of stagnation.
Even though China’s rising debt levels and over-reliance on property have long been part of economic debate, the voice of a ratings agency carried enough weight to renew a sell-off in Chinese assets and prompt state bank actions in markets.
“This is a financial war,” said Yuan Yuwei, founder and CIO of Water Wisdom Asset Management.
Moody’s move “would trigger foreign reduction in Chinese assets, and would also push up China’s funding costs, potentially leading to deterioration in asset quality.”
Authorities have taken a raft of economic support measures and targeted steps to prop up the stock market, including cutting stamp duty, slowing the pace of listings and getting state-backed funds to buy stocks.
China buying index funds to bolster market
In an apparent effort to calm the market, the official Shanghai Securities News reported on Wednesday that China’s securities watchdog will promote reforms to attract more long-term capital into the market.
And last week, state-owned China Reform Holdings Corp said it had started buying index funds to support the market, following a similar move by sovereign fund Central Huijin Investment.
But, on the other side of the trade, the weakening prospects for the Chinese economy could prove hard to shake off as confidence remains low.
“The pressures on Chinese stocks and the economy more generally are likely to increase if the cost of insuring the sovereign debt continues to rise and bailouts begin,” Ryan Yonk, economist at the American Institute for Economic Research, said.
Rob Carnell, Asia-Pacific Head of Research at ING said that China has used many tools already to drive up demand but with limited effect, “so getting people to regain confidence in this market is going to be really hard.”
Ultimately, analysts warn, sentiment can only stabilise sustainably if China delivers a credible longer-term roadmap for solving the structural weaknesses that are curbing its growth potential.
“The priority for China now is to stabilize growth momentum and raise confidence for the future,” Calvin Zhang, senior portfolio manager at Federated Hermes, said.
China should increase fiscal spending and address local governments’ hidden debt, Zhang said.
In October, China unveiled a plan to issue 1 trillion yuan ($139 billion) in sovereign bonds by the end of the year, raising the 2023 budget deficit target to 3.8% of gross domestic product (GDP) from the original 3%.
Moody’s cuts outlook for 18 Chinese companies
Major state-owned banks stepped up US dollar selling forcefully on Tuesday, and again on Wednesday.
Moody’s followed up its China move with changes to its outlooks on 18 Chinese corporates to negative on Wednesday.
China stocks opened down with the CSI-300 Index touching its lowest level since February 2019, before recouping earlier losses. It closed up 0.2%, with the Shanghai Composite Index down by 0.1%, while the Hang Seng Index rebounded and closed up 0.8%, with tech shares leading gains.
Chinese markets have had a torrid time this year as a shaky economic recovery and a deepening property crisis have added to geopolitical challenges, including protracted Sino-US tensions over tech and trade.
The CSI-300 has tumbled about 12% so far this year and is set to be one of the worst performers in the region.
“The CSI-300 index was hit the hardest in terms of valuation, as the index gets more allocations from foreign investors,” Pang Xichun, research director at Nanjing RiskHunt Investment Management Co, said.
High outflows putting pressure on yuan
China’s central bank, meanwhile, has used various tools in recent months to stem the yuan’s slide, including stronger fixings before the market open. But outflow pressure remains high.
China recorded its first-ever quarterly deficit in foreign direct investment in July-September, while Goldman Sachs data showed outflows from China reached $75 billion in September, the biggest monthly exodus since 2016.
Moody’s outlook cut could raise the stakes further, analysts said.
“This is a blow to the already low investor confidence in China,” said Qi Wang, chief investment officer of UOB Kay Hian’s wealth management division in Hong Kong.
Sovereign credit is the foundation of Chinese assets, so the move “would certainly impact the yuan exchange rate, and reduce global investors’ risk appetite.”
But not everyone is bearish.
Rival ratings agencies Fitch Ratings and S&P Global Ratings have made no changes to their respective China credit ratings. Fitch affirmed China’s A+ rating with a stable outlook in August, while S&P Global said on Wednesday it has retained China’s A+ rating with a ‘stable’ outlook.
Some market participants pointed to similar rating moves on the US as having limited long-term market impact.
Chinese media calls Moody’s ‘biased’
Chinese state media called Moody’s “biased” on Wednesday for its negative rating outlook on the economy, but some analysts said the government’s official reaction was more restrained and signalled Beijing’s worries about surging debt.
The Communist Party’s nationalist tabloid Global Times published an article citing economists as saying Moody’s decision was “biased and unprofessional, as it grossly exaggerated or manufactured risks and challenges.”
But in a statement responding to Moody’s move, the finance ministry only expressed “disappointment”, while a foreign ministry spokesperson said China was capable of deepening reform and addressing its challenges.
The Global Times’ former editor Hu Xijin, who remains a prominent Chinese commentator, wrote a blog post to praise the finance ministry’s “restraint”, saying its tone was “very commendable.”
Hu said it was more important to boost “domestic confidence” than “devote energy to arguing whether this (Moody’s move) is a ‘conspiracy’ or not,” adding this could be achieved by strengthening China’s post-pandemic recovery and resolving municipal debt and real estate risks.
- Reuters with additional editing by Jim Pollard
NOTE: Further detail was added to this report on December 6, 2023 on the CSI-300 index, Moody’s cutting the outlook for 18 firms today, and the Chinese media’s response to Tuesday’s downgrade.