Moody's: Policy effectiveness amid high leverage and China's rebalancing to drive sovereign credit quality in Asia Pacific

Moody's Investors Service says that leverage risk, the challenges and opportunities offered by rebalancing in China (Aa3 negative), and policy effectiveness will be key factors driving sovereign credit trends in Asia Pacific over the coming months.

High levels of public- and private-sector debt, which have built up over recent years, may weigh on sovereign credit quality as growth cools and financing conditions tighten.

For some countries in the region, China's transition away from an investment- and manufacturing-driven economy toward one based on consumption and services poses challenges. But China's rebalancing also provides opportunities for many Asian countries over a longer time horizon.

Meanwhile, each government's policy effectiveness will determine how its credit profile navigates this climate of subdued demand and greater financial uncertainty.

Moody's conclusions are contained in its just-released report on sovereigns in Asia Pacific, entitled "Policy Effectiveness Amid High Leverage and China's Rebalancing to Drive Outlooks."

Moody's notes that over the last five years, low global interest rates have coincided with financial deepening in many Asian markets, spurring an increase in leverage in the region. Risks posed by elevated debt levels, particularly as growth cools, have already contributed to negative rating actions on a number of economies in the region, and will remain a driver of sovereign creditworthiness ahead.

While systemwide leverage is an important barometer of risk, Moody's also focuses on whether the key borrowers within each economy are governments, corporations or households. The report dwells on how how asset buffers, macroeconomic trends and policy flexibility can mitigate or exacerbate the impact that leverage has on sovereign credit profile.

Slower growth in China, coupled with lower global commodity prices, has thus far hit Mongolia (B2 negative) the hardest in the Asia Pacific region. If China's efforts to reduce overcapacity in traditional industries and to open the capital account were to be accompanied by market volatility, the economies and financial sectors of Hong Kong (Aa1 negative) and Singapore (Aaa stable) could be exposed. However, Moody's does not expect a significant negative shock in this regard.

Moody's report points out that less attention has been given to the benefits that a successful rebalancing in China could bring to several Asian sovereigns. Chinese tourist arrivals in many countries across the region are climbing, while Australia (Aaa stable) and New Zealand (Aaa stable) could see growing Chinese appetite for high-value-added agricultural products. Australia is also well positioned to profit from rising Chinese demand for education and business services.

Asian frontier economies could furthermore take market share from China as low-cost production centers. Lower-income countries will also gain as Chinese infrastructure investment into Asian economies intensifies with China's Belt and Road strategy and the establishment of the Asian Infrastructure Investment Bank (unrated).

Moody's points out that policymakers across Asia face the challenge of reviving domestic growth in an environment of subdued global demand. Lower commodity prices and muted inflation offer monetary policy space to many central banks. However, most countries in Asia Pacific have less room for fiscal stimulus than they did prior to the global financial crisis. At the same time, a number of governments in the region are undergoing leadership transitions. The report identifies where Moody's expects such transitions to support policy effectiveness and structural reform, and for which sovereigns the impact of political change may be less certain.