Credit ratings agencies can be thought of as “bookies” to the financial investment community. Their function, rather like a turf accountant setting odds on the favourite for the day’s big race, is to offer a candid evaluation of the risk associated with bonds and other financial vehicles be they corporate or sovereign. Their ratings range from the ultra-secure triple A-rated investment grade bonds via lower classifications to the speculative or junk ratings. The poorer the rating ascribed then the greater the possibility that an investment might fail to deliver its promised return and, therefore, the higher the interest that an issuer needs to pay to attract the punters, er investors.
With that said, one of the major ratings agencies, Moody’s, has decided that the economic prospects for the world’s second largest economy are not as rosy as they might have been and consequently they have downgraded their evaluation of China’s sovereign debt. The rating has been reduced by one level from A1 to Aa3 and they describe the outlook as “negative” meaning that a further downgrade is likely within two year. The move indicates a higher perceived risk associated with Chinese sovereign bonds and therefore, it could increase the cost of state borrowing in the international money market. It is the first downgrade that Moody’s have made on China since 1989.
Chinese growth was officially the weakest seen for 26 years, but still came in at a dizzying 6.7%. Justifying the move, Moody’s commented that Chinese financial strength would: "erode somewhat over the coming years, with the economy-wide debt continuing to rise as potential growth slows".
Fundamentally, the question boils down to how well China can cope with its existing debt burden which is estimated to be 2.6 times the nation’s GDP. However, the exposure to this debt is mainly through state-owned enterprises rather than the international investment community.