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Moody’s had put its China A1 rating on negative outlook on Tuesday, which implies a higher risk of a downgrade in future. The rating agency cited risks of persistently lower mid-term growth, and rising evidence that the government and state companies would provide financial support to weak regions, posing broad downside risks to China’s fiscal, economic, and institutional strength.
We emphasize that a negative rating outlook will not impair China’s ability to refinance debt. Much of China’s debt is domestically financed, and its international bond issuance is relatively paltry. There may be some negative spillovers to China’s USD credit, particularly SOE and LGFV debt. Moody’s has a large presence in the China market, and their ratings will be affected by a change in the sovereign outlook. After announcing its negative outlook for China, Moody’s has placed the ratings of 26 Chinese LGFVs on review for downgrade. Such actions will pressure prices to an extent in the short-term, but we think the final impact will be much smaller, or even negligible.
Logically, if the outlook change is because the central government is taking on greater burden sharing with fiscally weak local governments, then this should also mean that the risks of an LGFV default would be lower than otherwise. This is where there is a clear inconsistency in applying a negative change in the sovereign rating outlook as a reason to lower ratings for Chinese LGFVs, even if this is a standard protocol for rating agencies. Furthermore, foreign investors have already pared exposure to LGFVs much earlier given strains to local government revenues and uncertainty of support from the government. Thus, contrary to negative rating implications for LGFV credit, investors should be feeling more comfortable that the central government is taking on a greater role in mitigating risks for LGFVs.
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