China’s finance ministry chastised Moody’s yesterday after the US rating agency downgraded Beijing’s sovereign credit rating, highlighting investor concerns over rising debt and the slow pace of economic reform intended to transform the country’s growth model.“Moody’s has overestimated the difficulties faced by China’s economy and underestimated the government’s ability to deepen reforms,” the ministry said in response to the downgrade, which rattled China’s markets and currency.

Moody’s downgraded China one notch from Aa3 to A1, its fifth-highest rating. On the credit scale used by rival agencies Fitch Ratings and Standard and Poor’s, the move is equivalent to a downgrade from double A minus to A plus. S&P still rates China at double A minus although with a negative outlook, while Fitch already has China at A plus.“The downgrade reflects Moody’s expectation that China’s financial strength will erode somewhat over the coming years, with economy-wide debt continuing to rise as potential growth slows,” said Marie Diron, the agency’s associate managing director for sovereign risk.The news initially unnerved Chinese investors. The yield on benchmark Chinese five-year government bonds spiked from 3.8 per cent to 3.95 per cent in the minutes following the announcement but returned to the previous level by midday, according to the National Interbank Funding Center. Domestic investors generally ignore foreign ratings of Chinese bonds, and foreign penetration of China’s bond market remains tiny, with foreigners owning about Rmb424bn ($61.5bn) of Chinese government bonds at the end of April, equal to 4 per cent of the outstanding total, according to China Central Depository and Clearing. Moody’s shifted its ratings outlook for China to negative in March last year, with S&P following suit four weeks later. Fitch — which has generally been more bearish on China than its counterparts — has maintained its A plus ratings with stable outlook since 2007.  Luke Spajic, who heads Pimco’s emerging Asia portfolio, said the risks highlighted by Moody’s had already been “well flagged” by the market. While Moody’s acknowledged China’s efforts to rebalance its economy away from reliance on debt-fuelled stimulus, it believes progress is too slow to arrest deterioration in its financial strength.“The importance the authorities attach to maintaining robust growth will result in sustained policy stimulus,” the agency said. “Such stimulus will contribute to rising debt across the economy as a whole.” Moody’s expects China’s direct fiscal debt to reach 40 per cent of gross domestic product by the end of next year and 45 per cent by 2020. In addition, it notes that China’s reliance on disguised fiscal spending through off-budget special purpose vehicles owned by local governments is likely to persist. The Financial Times reported this month on a World Bank assessment warning of risks from local government financing vehicles.“The ratings downgrade is a stark warning of the risks posed by rapidly rising leverage that could prove costly even if it does not result in a financial crisis,” said Eswar Prasad, economics professor at Cornell University.