Moody's Investors Service on Wednesday downgraded China's credit rating to A1 from Aa3, changing its outlook to stable from negative, citing concerns efforts to support growth will spur debt growth across the economy.
Marie Diron, senior vice president for Moody's soverign rating group, told CNBC's "Street Signs" on Wednesday that the catalyst for the downgrade was a combination of factors, including expectations that potential growth would fall to 5 percent by the end of the decade. It was Moody's first downgrade for the country since 1989, according to Reuters.
"Official growth targets are also moving down, but probably more slowly. So the economy is increasingly reliant on policy stimulus," she said, adding that was likely to spur increasing debt levels for the government.
"It's really the size of the leverage, the trends in leverage as well as the debt servicing capacities of the institutions that have that debt. When growth slows, then that points toward slower revenue growth, probably slower profitability and somewhat weaker debt servicing capacity," she added.
Unsurprisingly, China's finance ministry didn't agree with the move.
In a statement on its website, the ministry said the downgrade was based on an "inappropriate method" and that Moody's was overestimating the difficulties China's economy faced, while underestimating the government's efforts to tackle structural reforms and overcapacity.
Foreign-exchange markets reacted to the downgrade, with the Australian dollar dropping from levels around $0.7480 to as low as $0.7452 in the wake of the announcement. China is among Australia's largest export markets.
But China's yuan didn't react much, with the dollar fetching 6.8940 yuan at 9:38 a.m. HK/SIN, compared with Tuesday's close of 6.8890 yuan.
"Moody's expects that economy-wide leverage will increase further over the coming years. The planned reform program is likely to slow, but not prevent, the rise in leverage," Moody's said in a statement. "The importance the authorities attach to maintaining robust growth will result in sustained policy stimulus, given the growing structural impediments to achieving current growth targets. Such stimulus will contribute to rising debt across the economy as a whole."
It expected that while economic growth would remain relatively high, potential growth rates were likely to fall in the years ahead.
Moody's estimated that while the government budget deficit in 2016 was "moderate" at around 3 percent of gross domestic product (GDP), it expected the government's debt burden would rise toward 40 percent of GDP by 2018 and 45 percent by the end of the decade.
It also expected contingent and indirect liabilities would rise, pointing to policy bank loans, bonds issued by Local Government Financing Vehicles (LGFV) and other state-owned enterprises' (SOE) investments.
Moody's added that it expected economy-wide debt of the government, households and non-financial companies would rise, as economic activity tends to be financed with debt in the absence of a sizeable equity market.