Credit-rating agency Moody’s downgraded its outlook on Chinese government debt from “stable” to “negative” on Wednesday, citing uncertainty over authorities’ capacity to implement economic reforms, rising government debt and falling reserves.

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“Without credible and efficient reforms, China’s GDP [gross domestic product] growth would slow more markedly as a high debt burden dampens business investment and demographics turn increasingly unfavourable,” Moody’s said in a note on Wednesday. “Government debt would increase more sharply than we currently expect.”

Moody’s said its rating committee had discussed China’s status at a meeting on February 9, during which the country’s institutional and fiscal strength, as well as its susceptibility to event risks, were reviewed.

The agency said the downgrade was driven by expectations that China’s fiscal strength would continue to decline, and the fall in its foreign exchange reserves, which have shrunk by US$762 billion over the past 18 months.

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It also said that policymakers’ credibility was at risk of being undermined by incomplete implementation or partial reversals of some reforms.

“Interventions in the equity and foreign exchange markets over the past year suggest that ensuring financial and economic stability is also an objective, but there is considerable uncertainty about policy priorities,” Moody’s said.

Yet Moody’s retained China’s Aa3 rating, noting that the country’s sizeable reserves gave it time to implement reforms and gradually address economic imbalances.

However, the agency warned that it could further downgrade China’s rating if it saw a slowing down of the reforms needed to support sustainable growth and to protect the government’s balance sheet.

Trinh Nguyen, senior economist for emerging Asia at the global asset manager Nataxis, said: “It’s not a worrying sign yet, but rather a negative direction. That’s what Moody’s is flagging.

“But they have room to do this. They have one of the lowest government debts as a share of GDP in comparison to other emerging nations. And most importantly, as China has a current account surplus it can fund its own fiscal expansion.”

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