Moody’s downgraded China’s credit rating on Wednesday citing rising debt levels. The country’s benchmark equity index fell 1% but recouped losses. The reaction of the global stock markets was also muted. Given the fact that the global markets have been dealing with concerns about China’s slowing growth and debt levels for some time now, Moody’s announcement came across as more of a validation of the markets’ existing concerns and not so much of a surprise.
Impact of the downgrade
1. Foreign capital outflows could intensify. But this might not impact China much given its limited reliance on external debt. Nevertheless, the outflows could create downward pressure on Yuan going forward.
2. Liquidity could tighten. Market liquidity could tighten with investors demanding a premium for investing in Chinese assets/companies owing to higher credit risk. Further, tightening credit availability for companies seeking funds for expansion could hinder growth plans
3. Asset prices could go south. Lower liquidity could curtail personal, corporate investments and lead to a correction in asset prices

There is a bright side
The rating after the downgrade is A1 which is still an investment grade rating. This conveys the message that China’s debt situation is still manageable. $3tn worth of foreign reserves and a current account surplus provide comfort. The downgrade serves as a warning but is not the final word to China’s debt sustainability

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