China's moderating inflation rate bodes well for its sovereign credit rating in spite of uncertainty about the impact of deepening economic stresses emanating from Europe, Moody's Investors Service said on Monday.
Easing price pressures were probably the most significant development for the Chinese economy since Moody's issued its last formal credit analysis of the country's finances on April 26, said Thomas Byrne, Singapore-based senior vice president and regional credit officer in the firm's sovereign risk group.
"Inflation has come down. That's a definite positive as it gives the monetary authorities a bit more scope to stimulate the economy," Byrne told reporters in Beijing, where Moody's is holding a client conference on Tuesday.
"That's probably the biggest change to the positive."
Moody's last month confirmed China's A3 sovereign rating and said the outlook for it remained positive, supported by favourable medium-term growth prospects and strong government debt dynamics, adding that trade and financial exposures to problems in the euro zone were moderate to low.
Byrne said China's ratio of debt to GDP, including local government debt that is the direct responsibility of the central government, is about 33%, with maybe another 8% of GDP in contingent liabilities. That is low by global standards.
He said strong growth dynamics with relatively low inflation gave China a very strong credit profile from a pure economics point of view and was largely the reason why Moody's maintained a positive outlook on its rating.
The outlook for the rating has been positive since November 2010. A positive outlook broadly implies that the next ratings action is likely to be an upgrade, assuming trends noted at the time continue in the same direction. A negative outlook means the risk is tilted towards a downgrade.
Moody's typically has a two-year timeframe for making a ratings move after issuing an outlook, suggesting it is likely to decide on whether to change China's rating by November 2012.
But there were risks to the world's second-biggest economy that were not yet fully understood, Byrne said.
"On the other side of the balance sheet, the negative development has been the drop in demand from the European Union. This has had adverse consequences on Chinese exports," he said.
"That's the source of our new concern - what are the long term implications of the continuing economic stress in Europe on China?"
Dented European exports
A sharp slowdown in demand from the European Union, China's biggest customer, has dented exports and raised fears among investors that the country's vast factory sector is set for a damaging downturn in international trade.
China aims for annual growth of 10% in exports and imports this year and is running far short of both. The first four months of 2012 saw exports grow 6.9% on the previous year, while imports grew 5.1%.
A flurry of other economic data for April also missed expectations and prompted the central bank to lower banks' required reserve ratio (RRR) on May 12 by 50 basis points, the third move since November 2011, bringing RRR to 20%.
The consumer price index rose 3.4% in April year-on-year, slightly above economists' expectations but down from the 3.6% pace logged in March, giving Beijing more scope to loosen policy to help the economy.
China has since fast-tracked infrastructure investment and restated its intention to boost private sector participation in a wide range of state-controlled sectors, including electricity, oil and natural gas to help underpin growth.
China's policy announcements have come as the EU struggles to contain contagion risks from a Greek debt crisis that is unnerving global financial markets.
Greece remains in political deadlock after inconclusive elections earlier this month left the country still requiring a massive 130 billion euro sovereign debt bailout, but without a government able to agree the terms required to keep the country inside the euro zone.
The situation in Greece has intensified investor anxiety about the potential for a break up of the single currency.
Conservative parties have regained an opinion poll lead that would allow the formation of a pro-bailout government committed to keeping the country in the euro zone, a batch of new surveys showed on Saturday. Repeat elections are due on June 17.