Ratings agency Moody’s downgraded its outlook on China’s government credit ratings from stable to negative earlier this week (12/5/23). Moody’s expects Beijing’s support and possible bailouts for state-owned enterprises and local governments to decrease China’s fiscal, economic, and institutional strength. Moody downgraded its outlook for Chinese sovereign bonds, sending a signal to potential lenders that the risk of a default by Beijing has increased over the past year. However, China’s Finance Ministry was disappointed with Moody’s downgrade decision because the economy was improving.

China’s economy has been slowing down since the 2020 crackdown on excessive borrowing, following a string of debt defaults by numerous property developers. Local government finances have been strained without revenues from property transactions and real estate values. Also, state enterprises that need loans to grow have struggled to access credit from lenders directly affected by increasing property defaults.

Evergrande, a renowned property developer, was granted an extension until late January 2024 to revamp its debt and avoid possible liquidation. Evergrande was among the largest developers in China, but it has been struggling lately. In recent reports, the company reportedly owes more than $300 billion to investors whose properties were never built.

The downgrade could have several consequences for China. One immediate impact is the potential increase in the cost of borrowing for the Chinese government and companies. Lower credit ratings usually result in higher interest rates, making it more expensive for entities to access capital. This, in turn, could pose challenges for China’s economic growth and its ability to manage its debt burden.

Furthermore, the downgrade may erode investor confidence in the market. International investors may become more cautious about allocating funds to Chinese assets, leading to capital outflows and Yuan depreciation. This could create headwinds for the country’s currency, Yuan stability and exacerbate concerns about the overall health of the Chinese financial system.