Moody's Upgrades Debt Ratings for China, Hong Kong, Macau

China earned an upgrade to its credit rating on Thursday from Moody's Investors Service to reflect exceptional strength in its external payments, favorable government debt trends and continued progress in economic reform.

Moody's also raised the ratings on Hong Kong and Macau.

The firm raised China's long-term foreign currency bond rating to A1 from A2 with a stable outlook. "China's very strong external payments position provides insulation from external shocks and allows the authorities time to expand and deepen structural reform," Tom Byrne, a senior vice president at Moody's, said in a statement.

The external obligations of the government and state-owned banks were a fraction of China's $1.33 trillion in foreign currency reserves, Byrne noted. "We expect that China's external payments position will remain resilient to domestic and external pressures," he said.

Jun Ma, Deutsche Bank's chief China economist based in Hong Kong, said the upgrade was not a surprise given the strength of the economy. "I think the risk is more on the asset market side rather than on the real economy side. We're beginning to see another rally in the A-share market since earlier this week, and we cannot rule out the possibility that the rally will continue," he said, referring to Shanghai's benchmark index.

An asset price bubble was unlikely to have a serious impact on the economy, Ma added. "But it's going to have an impact on sentiment, and it will have an impact on certain segments of the population -- the most vulnerable investors."

Moody's described the performance of China's export sector as formidable despite the appreciation of the yuan against the dollar. Accession to the World Trade Organisation and strong foreign investment inflows had improved competitiveness, transforming China into the world's third-largest exporter.

No Great Surprise

China is likely to drive global growth this year, the International Monetary Fund said on Wednesday.

The Washington-based agency raised its forecast for China's 2007 growth to 11.2% from 10% on the heels of surprisingly strong annual growth in the second quarter of 11.9 percent.

"China seems to be going from strength to strength at this point. It's hitting on all cylinders," said Charles Collyns, deputy director of the IMF's research department. Byrne said mutual national interests meant trade friction with the United States and the European Union was unlikely to lead to a serious rift. "Nevertheless, the possibility of heightened trade frictions poses some risk to the sustainability of China's exceptional economic growth performance," he said.

Tim Condon with ING Financial in Singapore said markets would not be surprised by the upgrade. "The credit spread on China sovereigns is very tight. For high-yield corporates, an upgrade of the sovereign rating will have some positive feel-good factor that will spread to the corporates, but it won't have a big impact," he said.

Moody's upgraded Hong Kong's foreign- and domestic- currency bond ratings from Aa3 to Aa2 -- two notches above China -- to reflect a strengthening of the government's finances and the former British colony's external position.

"The Hong Kong government has almost no debt and large and growing fiscal reserves, equivalent to about one quarter of GDP," said Moody's Vice President Steven Hess.

"This strong position gives the government considerable financial flexibility and provides a strong buffer against potential shocks emanating from the mainland or elsewhere."

Hong Kong in the past few years overturned a series of big deficits run up in the years following the 1997/98 Asian financial crisis and recently announced a HK$58.6 billion (US$7.5 billion) fiscal surplus for the year ended March 2007.

The economy is robust, having expanded by 7.6% on average in the past three years and is set to grow 5.5% this year, according to a Reuters poll, driven by strong consumer spending and solid export growth.

Moody's upgraded Macau, which like Hong Kong is a special administrative region of China, to Aa3 from A1 in light of the government's big budget surplus and large external net creditor position. The government of the tourism and gambling enclave has no debt.