China

Moody’s has downgraded China’s debt rating for the first time in nearly 30 years, warning that the country’s financial health will decline after years of credit-fueled economic stimulus.

The downgrade to A1 from Aa3 is the first since 1989, the same year as the Tiananmen Square protests, and brings Moody’s in line with Fitch Ratings. Standard & Poor’s rates China’s debt a notch higher.

Moody’s said the move reflects its expectation that “China’s financial strength will erode somewhat over the coming years, with economy-wide debt continuing to rise as potential growth slows. While ongoing progress on reforms is likely to transform the economy and financial system over time, it is not likely to prevent a further material rise in economy-wide debt, and the consequent increase in contingent liabilities for the government.”

China’s Finance Ministry responded that Moody’s had overestimated the risks to the economy and the downgrade was based on “inappropriate methodology.”

“Moody’s views that China’s non-financial debt will rise rapidly and the government would continue to maintain growth via stimulus measures are exaggerating difficulties facing the Chinese economy, and underestimating the Chinese government’s ability to deepen supply-side structural reform and appropriately expand aggregate demand,” the ministry said in a statement.

China has been using debt-based spending to stimulate the economy since the global financial crisis in 2008, with local officials and state-run companies borrowing heavily to invest in infrastructure and real estate projects.

“But debt no longer packs the same economic punch for China,” The New York Times noted. “An aging work force, smaller productivity gains and the sheer math of diminishing returns mean it must borrow more money to achieve less growth.”

China’s debt has been increasing lately by an amount equal to about 15% of the country’s output each year, to keep the economy growing from 6.5% to 7%.

Moody’s downgrade “is yet another sign of the challenges faced by China, which is juggling rising leverage, declining economic growth rates and ongoing structural reforms,” Luc Froehlich, head of investment directing for Asian fixed income at Fidelity International, told The Guardian.

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