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S&P cuts China's credit rating, citing increasing economic, financial risks

  • S&P Global Ratings downgraded China's long-term sovereign credit rating by one notch on Thursday to A+ from AA-
  • S&P's downgrade follows a similar demotion by Moody's Investors Service in May.
  • S&P also lowered China's short-term rating to A-1 from A-1+.

S&P Global Ratings downgraded China's long-term sovereign credit rating by one notch on Thursday to A+ from AA-, citing increasing risks from the country's rapid build-up of credit.

"The downgrade reflects our assessment that a prolonged period of strong credit growth has increased China's economic and financial risks," S&P said in a statement, adding that the ratings outlook was stable.

S&P's downgrade follows a similar demotion by Moody's Investors Service in May and comes as the government grapples with the challenges of containing financial risks stemming from years of credit-fuelled stimulus spurred by the need to meet official growth targets.

Wang Zhao | AFP | Getty Images

It also comes less than a month ahead of a highly sensitive twice-a-decade Communist Party Congress which will see a key leadership reshuffle.

Stephen Gallo, European head of FX strategy at BMO Financial Group told CNBC via email that China's domestic debt dynamic is a long-standing issue that most investors are already well aware of.

"To be sure, the move by S&P this morning merely brings the ratings agency into line with where Moody's and Fitch already were (5 notches below triple-A). Therefore, the direct economic/market impact of today's decision by S&P is low."

Gallo further explained that this is not going to necessarily see direct translation into a weaker currency because restrictions on outbound flows are still relatively tight.

"If anything, the decision by S&P highlights the degree to which China will aim to keep leverage growth within the domestic economy low-to-moderate as opposed to high. This means that neither onshore rates nor the RMB are likely to drop sharply as a result of today's news."

Investors remain concerned about China

Concerns about China's sustained strong credit growth appear to be increasing, even as first-half economic growth beat expectations.

China's stock markets were already closed Thursday when the downgrade was published, and there was little reaction from the yuan.

S&P said that recent efforts by the government to reduce corporate leverage could stabilize financial risks in the medium-term.

"However, we foresee that credit growth in the next two to three years will remain at levels that will increase financial risks gradually," S&P said.

S&P also lowered China's short-term rating to A-1 from A-1+.

Diana Kiluta Amoa, emerging market debt portfolio manager at JP Morgan Asset Management told CNBC via email that the downgrade doesn't come as a surprise.

"S&P's downgrade of China's sovereign rating from AA-/negative to A+/stable today does not come as a surprise given Moody's downgrade earlier in the year and only aligns the ratings with the other two rating agencies."

Amoa further explained that any fallout as a result of this decision will be short-lived. Going forward, the outcome from the upcoming party congress and the government's

"Going forward, the outcome from the upcoming party congress and the government's commitments to further reforms will be the bigger drivers for both market sentiment and ratings agencies."