Moody’s Investors Service downgraded China’s credit rating Wednesday – from Aa3 (Double A-3) to A1 – saying it expects China’s economy to erode in coming years as growth slows and its debt burden continues to rise. The downgrade comes as the government faces new financial challenges after years of credit-fueled stimulus.

Craig Erlam, senior market analyst at foreign exchange firm Oanda, said the credit downgrade comes as no surprise. “Because talk of Chinese debt and concerns about the size of Chinese debt has been going on for the last few years.  They seem to be very reliant on these high levels of growth, which has been slowing,” according to Erlam.

China’s economy, the second largest in the world, grew 6.7 percent in 2016, down from 6.9 percent the previous year, the slowest pace since 1990. Erlam says the next few years could be challenging.

“They’ve [the Chinese government] talked about wanting to move away from an investment and export-led economy and focus more on domestic consumption and look at a more sustainable model. But, as we’ve seen over the last couple of years, as soon as it runs into any difficulties – it seems to revert back to where it was a couple of years ago and start spending more money on infrastructure.”

Moody’s expects the government’s direct debt burden to rise to 40 percent of GDP by 2018 and closer to 45 percent by the end of the decade. That’s still well below the 60 percent debt to GDP warning line for the European Union.

China’s Finance Ministry said the downgrade overestimates the risks of rising debt and claims it was based on “inappropriate methodology.” The downgrade is likely to increase the cost of borrowing, but analysts say the one-notch downgrade remains comfortably within the investment grade rating range.

Triple A is the highest rating for creditworthiness, followed by Double A, then Single A. C represents the weakest creditworthiness and means default is imminent.  

China’s Shanghai Composite Index fell more than 1 percent after the credit downgrade while the value of the yuan slipped briefly 0.1 percent against the U.S. dollar.
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