China’s debt problem has finally started to take an ominous form. Moody’s Investor Services reduced its outlook on the economy. In a surprise move, marking the first time in three decades, Moody’s recently cut China’s credit rating. This comes amongst claims by analysts and government alike, that China will be able to manage its growth rate for 2017 after a tremendous first quarter.
Chinese stocks have slumped, making investors nervous about the country’s equity market. Here are 4 reasons why the stocks have experienced a downfall.
Moody’s Credit Rating Downgrade
China’s credit rating was cut to A1 from a Aa3 by Moody’s. They claimed that there could be a ‘material rise’ in debt in China. The finances of the state will be heavily burdened because of the nation-wide debt crisis. The total outstanding credit in China is 260 percent of the GDP in 2016. It was 180 percent in 2008.
Markets reacted to the credit rating downgrade as they slumped with the Shanghai index falling by 1.3 percent. The stocks went to their lowest since October 2016.
A Looming Debt Issue
The debt crisis is making it difficult for China and China’s Stocks to leave some breathing space in its growth spree. The market is wobbling under the debt burden and there is a chance that a margin call will be near. Many stocks are pledged for repayment for debt. The market could run into trouble if the problem is not solved quickly.
Investors Dump China’s Stocks and Equities
The Shanghai gauge fell by 5 percent in the recent quarter, making it the world’s worst performing index. Industrial shares, health care shares and materials shares are hit the hardest after the market slump. China’s 10-year government debt yield is hovering over its 2-year high at 3.68 percent. The growth projects are slowing and may be close to 5 percent in the next few years. Additionally, China may also go on a higher leverage.
Authorities Face the Burden
Chinese authorities have called the surprise move by Moody’s an underestimation of the government’s ability to reform the economy. China is now making a slow and painful move towards a consumer driven economy. The authorities are trying to stop further debt. However, for an economy running on debt, this could be a tough move. The change will be difficult and Moody’s is not sure about the government’s ability to do it successfully.
China is already facing a fall in its foreign currency reserves and a herculean transition from debt-driven to consumer-driven economy will not come easy.