SHANGHAI – Moody’s Investors Service cut its outlook for Chinese sovereign bonds to negative, underscoring deepening global concerns about the level of debt in the world’s second-largest economy.

Moody’s lowered its outlook to negative from stable while retaining a long-term rating of A1 on the nation’s sovereign bonds, according to a statement on Dec 5.

China’s use of fiscal stimulus to support local governments and its spiralling property downturn is posing risks to the nation’s economy, the credit ratings agency said.

Beijing pushed back soon after the outlook change was announced, saying that it was “disappointed” with Moody’s decision and that the nation’s economy “will be highly resilient and has large potential”.

The impact of the property downturn is well under control, the Finance Ministry said in a statement.

China also ramped up its support for the renminbi as market sentiment took a hit after Moody’s action.

The People’s Bank of China set the daily reference rate for the currency at 7.1140 per US dollar, versus an average estimate of 7.1486. The gap between the two was the largest in more than two weeks, a sign that Beijing is boosting its efforts to prevent declines in the Chinese currency.

“Policymakers just want to keep up with the same messaging of wanting a steady yuan and not let Moody’s derail the policymakers’ efforts,” said OCBC Bank strategist Christopher Wong.

The market “can’t rule out policymakers stepping in if there is excessive volatility in yuan”, he added.

In a statement late on Dec 5, China Chengxin International Credit Rating, one of the leading domestic rating agencies, said the outlook for the nation’s sovereign credit was stable, adding that the government has “ample” room to control the rise in debt risks when compared with Western countries.

The change in Moody’s thinking comes as China’s deepening property rout triggers a shift towards fiscal stimulus, with the country ramping up its borrowing as a main measure to bolster its economy.

That has raised concerns about the nation’s debt levels, with Beijing on track for record bond issuance in 2023.

“These ratings downgrades or negative outlook shifts often mark the low in terms of bad news and market sell-offs. I wouldn’t see this being the case in two to three months’ time,” said Mr Viraj Patel, global macro strategist at Vanda Research. “It’s hard for things to get worse than current bearish expectations, and it takes only a little to see a tactical rebound or short squeeze.”

China’s economy has struggled for traction in 2023 as a rebound from restrictive zero-Covid policies proved to be weaker than expected and the property crisis deepened.

Data last week showed that both manufacturing and services activities shrank in November, bolstering a belief that more government action is needed to support a faltering recovery.

In October, Chinese President Xi Jinping signalled that a sharp slowdown in growth and lingering deflationary risks will not be tolerated, as the government increased its headline budget deficit to the largest in three decades.

At 3.8 per cent for 2023, the deficit-to-gross domestic product ratio is well above a long-adhered-to 3 per cent limit.

The revision allowed the central government to sell 1 trillion yuan (S$189 billion) of additional sovereign bonds within the year to support disaster relief and construction. Local governments were also selling special refinancing bonds to swap some off-balance sheet debt carrying higher costs.

Moody’s said: “Considering the policy challenge posed by local government debt, the central government is focused on preventing financial instability.

“Still, maintaining financial market stability while avoiding moral hazard and containing fiscal costs of support is very challenging.”

The renminbi was little changed in onshore and overseas trading on Dec 5, while the yield on China’s 10-year government bonds was steady at 2.68 per cent.

The MSCI China Index slid 1.7 per cent, on course for its lowest close since November 2022.

The gauge held on to most of its losses after Moody’s move.

China’s big state-owned banks sold dollars in large amounts against the renminbi in the onshore market after Moody’s move, according to traders.

Some commercial lenders followed suit in offloading the greenback, helping to trigger a rebound in the Chinese currency, said the traders, who asked not to be named.

Moody’s last cut its credit rating on China in 2017, to A1 from Aa3, on the likelihood of a material rise in economywide debt and the impact that would have on state finances. That was its first China debt downgrade since 1989.

Earlier in 2023, Fitch Ratings said in an interview with Bloomberg Television that it may reconsider China’s A+ sovereign credit score. The firm recently affirmed such a rating with a stable outlook.

S&P Global Ratings has kept China’s ratings at A+ with a stable outlook since its last downgrading in 2017 that followed a similar move by Moody’s.

“The risk of a rating downgrade is unlikely to reverse the debt issuances plan, which could help ease concern over the property sector and China’s sluggish growth,” said Mizuho Securities chief Asian FX strategist Ken Cheung. “The impact of a cut to the rating’s outlook on bond flows should prove limited, while the China-US rate spread is still a key driver.” BLOOMBERG