Moody’s Investors Service, a reputable credit rating agency, has recently downgraded China’s debt outlook from stable to negative. According to Moody’s, they made this change due to the expectation that the national government will intervene in financially-stressed regional and local governments' situations.

Despite the negative outlook, Moody’s has maintained China’s long-term rating at A1. However, they have expressed concerns about the potential risks that could arise from the government and wider public sector stepping in to provide financial support to troubled regional and local governments, as well as state-owned enterprises. These risks could have broad implications for China’s fiscal, economic, and institutional strength.

One factor contributing to the financial difficulties faced by regional and local governments is China’s property market troubles. These troubles have resulted in a decline in land sale revenue, which accounted for a significant 37% of their total revenue in 2022, apart from central government transfers. Moody’s warns that regions heavily reliant on land sales will struggle to compensate for the loss of this revenue from other sources.

Moreover, Moody’s estimates that approximately one-third of state-owned enterprises' debt, equivalent to around 40% of China’s GDP, has an interest coverage below 1. This indicates weak debt sustainability. Although not all state-owned enterprises are expected to require direct government support, even if a moderate proportion does so in the medium term, it could significantly increase contingent liabilities for the sovereign. This would result in higher costs for financial support and diminish fiscal strength, creating additional challenges for China.

In addition to Moody's assessment, Chinese stocks experienced a difficult day. The Hang Seng index fell by 1.9%, while the Shanghai Composite index dropped by 1.7%.

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