Market Turmoil: Moody's Warning Wipes Out China's Reopening Gains

Moody's downgrade of China's government credit ratings to negative has intensified bearish sentiment in Chinese stocks and assets. Concerns over the redirection of financial support towards troubled regional and local governments and state-owned enterprises have raised doubts about China's fiscal strength. One-third of outstanding state-owned enterprise debt, equivalent to almost 40% of China's GDP, has an interest coverage ratio below 1, indicating potential defaults.
Jan. 29, 2024 16:56
Market Turmoil: Moody's Warning Wipes Out China's Reopening Gains

Moody's Investors Service has revised its outlook on China's government credit ratings from stable to negative, adding to the already bearish sentiment surrounding Chinese stocks and assets. The shift in outlook reflects growing concerns about the country's fiscal and economic stability, with Moody's citing evidence of the Chinese government redirecting financial support towards stressed regional and local governments (RLGs) and State-Owned Enterprises (SOEs). This reallocation of resources raises questions about the broader downside risks to China's fiscal strength and economic integrity.

One of the most concerning findings from Moody's is the state of SOE debt, with around one-third of the outstanding debt having an interest coverage ratio below 1. This indicates that these companies do not generate enough earnings to cover interest expenses, potentially leading to defaults unless state bailouts are provided. Additionally, the era of robust economic growth that China has experienced in recent decades appears to be fading. Moody's projects a less optimistic outlook for China's GDP growth, estimating it to be 4.0% for 2024 and 2025, and averaging 3.8% from 2026 to 2030. By 2030, potential growth is expected to decline to around 3.5%, influenced by structural factors such as a weakening demographic profile.

The market reaction to these developments has been significant, with large-cap Chinese equities experiencing a sharp decline. The iShares China Large-Cap ETF, which tracks large-cap Chinese equities, has plunged over 10% in the last 10 trading sessions, marking the worst performance in over a year. This decline has nearly wiped out the gains from the "reopening trade" that followed initial speculations about the reopening of China's economy post-pandemic lockdowns. Chinese stocks are now approximately 29% lower than the highs seen in late January 2023.

On Tuesday, the three largest holdings in the iShares China Large-Cap ETF - Tencent Holdings Ltd, Alibaba Group Holdings Ltd., and Meituan - all traded negatively. Among the thirteen largest Chinese large-cap companies traded on the U.S. market, 10 recorded negative daily changes in response to Moody's news. Yum China Holdings experienced the steepest decline at 3.6%, while NIO Inc. emerged as the top performer, rising by 5.2%.

Overall, Moody's shift in outlook on China's government credit ratings has intensified concerns about the country's fiscal and economic stability. The market has reacted strongly, with Chinese stocks experiencing significant declines. The future of China's economic growth also appears less optimistic, with projections indicating a slowdown in GDP growth in the coming years.

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