China's Aa3 Rating Supported by Controlled Growth Slowdown, Says Moody's

Moody's Investors Service, in its annual report on China, says that the sovereign's Aa3 foreign and local currency bond ratings remain supported by its relatively high economic strength and very high government financial strength, which are not jeopardized by the country's new era of slower growth.


The rating agency also indicated that the country's low -- but not insignificant -- susceptibility to event risk, along with its moderate institutional strength, currently constrain its rating. The outlook for China's credit rating is stable.


Moody's Aa3 rating on China anticipates that the government will implement effective macro-prudential regulations and advance broad reforms that will help contain latent risks which could undermine China's new, more moderate growth path. These risks notably include contingent fiscal liabilities at the local government level and rapid bank and nonbank credit growth. The former present more immediate risks to government finances and to the banking sector.


The report describes in detail Moody's assessment of the four key factors constituting its sovereign bond rating methodology. Moody's considers China's economic strength to be high; its institutional strength to be moderate; its government financial strength to be very high; and its susceptibility to event risk to be relatively low and manageable.


Underpinning China's credit fundamentals is continued robust economic growth against a backdrop of low inflation. Moody's projects that real GDP will grow around 8.0% this year and 7.5% next year, and that China's growth will moderate further, but will remain well above average global growth over a five-year horizon.


China's strong general government finances are reflected in its small budget deficits, moderate gross financing requirements, and a moderate on-budget debt burden slightly under 30% of GDP. Contingent liabilities mainly associated with local government off-budget investment expenditure, could, however, add to the government's debt burden should a further round of local-level liability crystallization occur.


The country's external position remains exceptionally strong. Neither the government nor the banking sector relies on external funding, therefore reducing vulnerability to global financial market disturbances. China's system-wide net asset international investment position of about 21% of GDP in 2012 is one of the strongest for a major economy globally.


At the same time, Moody's says that governance and transparency challenges constrain the sovereign's institutional strength at a moderate assessment.China's susceptibility to political (domestic and geopolitical), financial sector or economic event risks is low, although risks in the financial sector have risen.


China's economic growth in the years after the 2008 global financial crisis has become more dependent on a relatively rapid expansion in bank credit. The even more rapid growth in non-bank credit also poses indirect risks to the banking sector, although it does not pose an immediate risk to the balance sheets of the banks. However, Moody's notes that recent banking and government debt crises have often been preceded by credit booms.


China's strengths, challenges, and risks are reflected in the sovereign's Aa3 rating and are captured in the Sovereign Bond Rating Methodology's scorecard-indicated rating range of Aa2-A1.


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