SHANGHAI/HONG KONG (Reuters) - Moody's (NYSE:MCO) negative outlook on China has intensified Beijing's battle with market bears, raising pressure on the government for more forceful measures to prop up sinking stocks and stabilise the yuan as investor confidence deteriorates.
In its Tuesday announcement, the ratings agency flagged weakening growth prospects, adding to mounting global concerns that China's economic miracle is over, potentially leaving the world's second-largest economy stuck in a middle-income trap.
While keeping China's sovereign rating at A1, Moody's cut its outlook to negative from stable, citing surging municipal debt and property market woes. Such concerns have prompted other institutions to draw comparisons with Japan's similar macroeconomic symptoms before its "lost decades" of stagnation.
Even though China's rising debt levels and over-reliance on property have long been part of the conversation, the voice of a ratings agency carried enough weight to renew a sell-off in Chinese assets and prompt state bank actions in markets.
"This is a financial war," said Yuan Yuwei, founder and CIO of Water Wisdom Asset Management.
Moody's move "would trigger foreign reduction in Chinese assets, and would also push up China's funding costs, potentially leading to deterioration in asset quality."
Authorities have taken a raft of economic support measures and targeted steps to prop up the stock market, including cutting stamp duty, slowing the pace of listings and getting state-backed funds to buy stocks.
In an apparent effort to calm the market, the official Shanghai Securities News reported on Wednesday that China's securities watchdog will promote reforms to attract more long-term capital into the market.
And last week, state-owned China Reform Holdings Corp said it had started buying index funds to support the market, following a similar move by sovereign fund Central Huijin Investment.
But, on the other side of the trade, the weakening prospects for the Chinese economy could prove hard to shake off as confidence remains low.
"The pressures on Chinese stocks and the economy more generally are likely to increase if the cost of insuring the sovereign debt continues to rise and bailouts begin," said Ryan Yonk, economist at the American Institute for Economic Research.
Rob Carnell, Asia-Pacific Head of Research at ING said that China has used many tools already to drive up demand but with limited effect, "so getting people to regain confidence in this market is going to be really hard."
Ultimately, analysts warn, sentiment can only stabilise sustainably if China delivers a credible longer-term roadmap for solving the structural weaknesses that are curbing its growth potential.
"The priority for China now is to stabilize growth momentum and raise confidence for the future," said Calvin Zhang, senior portfolio manager at Federated Hermes (NYSE:FHI).
China should increase fiscal spending and address local governments' hidden debt, Zhang said.
In October, China unveiled a plan to issue 1 trillion yuan ($139 billion) in sovereign bonds by the end of the year, raising the 2023 budget deficit target to 3.8% of gross domestic product (GDP) from the original 3%.
YUAN WORRIES
China's blue-chip index hit its lowest level in nearly five years on Wednesday.
Major state-owned banks also stepped up U.S. dollar selling very forcefully on Tuesday, and again on Wednesday. China's central bank has used various tools in recent months to stem the yuan's slide, including stronger fixings before the market open.
Still, outflow pressure remains high.
China recorded its first-ever quarterly deficit in foreign direct investment in July-September, while Goldman Sachs data showed outflows from China reached $75 billion in September, the biggest monthly exodus since 2016.
Moody's outlook cut could raise the stakes further, analysts said.
"This is a blow to the already low investor confidence in China," said Qi Wang, chief investment officer of UOB Kay Hian's wealth management division in Hong Kong.
Sovereign credit is the foundation of Chinese assets, so the move "would certainly impact the yuan exchange rate, and reduce global investors' risk appetite."
But not everyone is bearish.
Rival ratings agencies Fitch Ratings and S&P Global Ratings have made no changes to their respective China credit ratings. Fitch affirmed China's A+ rating with a stable outlook in August, while S&P Global said on Wednesday it has retained China's A+ rating with a 'stable' outlook.
Some market participants pointed to similar rating moves on the United States as having limited long-term market impact.
"Just as most people shrugged off the U.S. downgrade, most investors will shrug off the China downgrade," said Jason Hsu, chief investment officer at Rayliant Global Advisors.