Moody’s Downgrade of China Rating and Gold

On Wednesday, Moody’s downgraded China’s rating from Aa3 to A1. What does it mean for the gold market?

Moody’s Investors Service cut its credit rating on China’s sovereign debt by a notch. The agency also changed its outlook for China from negative to stable. It is the first time Moody’s has downgraded the country since 1989. The reason was worries about China’s growing debt. The agency explained:

“The downgrade reflects Moody's expectation that China's financial strength will erode somewhat over the coming years, with economy-wide debt continuing to rise as potential growth slows. While ongoing progress on reforms is likely to transform the economy and financial system over time, it is not likely to prevent a further material rise in economy-wide debt, and the consequent increase in contingent liabilities for the government.”

Indeed, total debt in the Chinese economy increased from about 160 percent of GDP in 2008 to about 260 percent of GDP in 2016, a level very high relative to other developing countries, or even unsustainable in the long run.

However, the market reaction to the cut was rather muted. This is because the downgrade did not tell us anything new. Everyone on the planet is totally aware of the risk associated with the Chinese debt. Moreover, Fitch and Standard & Poor’s have so far left their evaluations unchanged, at investment grade. And the cut should not impact the Chinese economy significantly, because China’s external debt is low by international standards. Hence, the downgrade isn’t likely to trigger panic, especially that the outlook was changed to stable.

The take-home message is that Moody’s cut China’s rating from Aa3 to A1 over slowing growth and debt fears. The country is heavily indebted, so there is a risk of economic crisis in the long term, which could spur safe-haven demand for gold. However, the downgrade did not provide any new information, so the short-term impact on gold prices should be limited, at best.