China’s credit outlook has been downgraded by Moody’s after it raised concerns over mounting debts in the world’s second-largest economy.
The ratings agency said policymakers faced the “very challenging” task of managing debts racked by state-owned enterprises, while also controlling a property crisis.
It cut its outlook for Chinese debt from “stable” to “negative”, which increases the risk of a full downgrade from its A1 investment grade rating in the next 18 months.
It comes as the Chinese Communist Party tries to revive a flagging economy after the removal of strict zero Covid measures.
However, it is doing so while extending financial aid to an embattled property sector, while also supporting local governments burdened by more than 90 trillion yuan (£10 trillion) in debts.
The property crisis was sparked by Evergrande, China’s biggest developer, which has been been under pressure since defaulting on its offshore bonds in 2021.
The company now faces the threat of liquidation although a Hong Kong court recently gave the company more time to reach a potential debt deal.
Moody’s warned China that “maintaining financial market stability while avoiding moral hazard and containing fiscal costs of support, is very challenging”.
It said growing debt risks posed “a complex policy dilemma” because Beijing is unable to prop up the entire sector without threatening wider financial stability.
Around a third of outstanding debt owed by state-owned enterprises – equal to about 40pc of China’s GDP – could be at risk due to difficulties meeting interest payments.
It said policymakers also faced a difficult balancing act providing financial support “in a timely and orderly, yet targeted fashion in a way that supports growth and investment”.
Moody’s said Chinese growth was likely to slow from around 5pc this year to around 3.8pc by the end of the decade.
It said: “To offset the diminished role of the property sector over the medium term, substantial and co-ordinated reforms will be needed for consumption and higher value-added production to drive growth.”
Moody’s said its growth forecasts reflected belief that China could successfully implement economic reform, built around boosting consumer spending.
However, it added: “Significant execution risk exists, exacerbated by unpredictability surrounding how and what reform measures will be taken.
“Moreover, in the near-term, risks to growth remain, as the downsizing of the property sector is a major structural shift in China’s growth drivers. This could represent a more significant drag to China’s overall economic growth rate than expected.
“A more pronounced slowdown in growth in the near to medium term would exacerbate local government deficits and debt further.”
Moody’s added: “Absorbing a significant portion of these contingent liabilities across the public sector would come at material costs, which would undermine China’s fiscal strength and potentially its creditworthiness.”
Moody’s also sounded the alarm over president Xi Jinping’s crackdown on big tech and the education sector, which it warned could deter private investment and weigh heavier on economic growth.
The agency said a “lack of predictability in the tools and commitment to support the private sector” could impact investment and growth worse than expected.
If Moody’s were to go further and downgrade China’s credit rating, it would only be the second time since 1989 – when it also warned about rising debt levels and the impact on the country’s finances.
The Chinese government said it was “disappointed” by Moody’s decision.
It said the Chinese economy remained “highly resilient and has large potential” with the impact of the property downturn under control, according to a statement released by the finance ministry.