Moody's lowers China outlook after Fitch downgrade

Cites concerns about the risk that excessive local government borrowing poses to the wider economy

Moody's Investors Service on Tuesday affirmed China's government's bond rating of Aa3 but cut the outlook to stable from positive, the second pessimistic revision by a foreign ratings agency this month.

Last week, Fitch Ratings cut China's long-term local currency credit rating to A-plus from AA-minus, citing concerns about the risk that excessive local government borrowing posed to the wider economy. Moody's referred to the same issue in justifying its negative revision.

"Progress has been less than anticipated in the process of both reducing latent risks by making local government contingent liabilities more transparent and in reining in rapid credit growth; therefore, some of the upward pressure on the Aa3 rating has eased," it said.

Moody's said it affirmed the Aa3 rating because of China's credit fundamentals, which have been underpinned by continued robust economic growth, strong central government finances and an exceptionally strong external payments position.

The report said more reform would be necessary to prevent a buildup of pressures that could increase the risks of a hard landing for the Chinese economy. But it credited China for maintaining better fiscal metrics than Belgium or France, and noted that China's massive international investment position means its external assets exceed its domestic liabilities to the tune of $1.8 trillion.

"Only a handful of highly rated advanced industrial economies - such as Norway, Switzerland, Japan, Hong Kong and Singapore - have a stronger international investment position."

China has seen rapid credit expansion as a result of Beijing's stimulus in 2008-09 to counter the global crisis, but the country has had trouble shaking off the hangover created by sloppy asset allocation and investment bubbles resulting from the flood of cheap cash.

Local government financing vehicles stand accused of making investments in vanity projects and ghost cities that are unlikely to produce sufficient returns to pay off bank loans.

The head of China's National Audit Office (NAO) recently estimated that outstanding debt of local and central governments was 15 to 18 trillion yuan -- equal to 29 to 35 percent of GDP -- at the end of 2012.

But even as Beijing has moved to clean up balance sheets at Chinese banks, borrowers and lenders have collaborated to develop new forms of off-balance sheet financing that regulators feel are both concealing and complicating the risk bad loans pose to the wider economy. (Reporting by Ian Chua and Pete Sweeney; Editing by Neil Fullick)