For the first time, Fitch Ratings has downgraded one of its sovereign ratings of China, citing the rapid expansion of credit in the country.
The international ratings agency announced yesterday that it had cut China's long-term local-currency debt rating to A-plus from AA-minus.
"Risks over China's financial stability have grown," said Fitch. "Credit has grown significantly faster than [gross domestic product] since 2009. China experienced the second-fastest expansion of credit, behind only Qatar, between the end of 2009 and the end of June 2012."
The stock of bank credit extended to China's private sector represented 135.7 per cent of GDP at the end of 2012, the third-highest of any Fitch-rated emerging market.
Fitch believes the total amount of credit in the mainland's economy, including credit created by various forms of shadow banking, reached 198 per cent of GDP at the end of 2012, up from 125 per cent at the end of 2008.
"The proliferation of other forms of credit beyond bank lending is a source of growing risk," it said.
Fitch's analysis found the debt of mainland local governments rose to 12.85 trillion yuan (HK$16 trillion) at the end of last year, or 25.1 per cent of GDP, up from 23.4 per cent a year earlier.
It said local governments probably had significant additional contingent liabilities arising from local government financing vehicles, which raise funds for infrastructure projects.
"Lack of transparency over the indebtedness of local governments is a shortcoming for China," Fitch said. "China has a less favourable record on inflation management than its peers."
A report by rival ratings agency Moody's said: "The latest Chinese bank results signal a deterioration in asset quality. We expect more non-performing loans to surface throughout 2013, because of worsening indicators such as the level of special-mention loans and delinquent loans."
Moody's has not, however, downgraded its ratings of Chinese banks. It said it did not see a significant deterioration of their asset quality within the next 18 months because delinquencies among local government financing vehicles had been "limited" so far.
"We also see receding pressure on real estate developers that alleviates our concern [over] rising delinquency in their borrowing, thanks to strong demand for housing as well as efforts by developers to conserve cash," it said.
Fitch affirmed China's long-term foreign-currency rating at A-plus with a stable outlook, citing the country's huge US$3.39 trillion of foreign reserves.
It also affirmed its long-term foreign currency rating of three state policy banks, China Development Bank, Agricultural Development Bank of China and Export-Import Bank of China, all at A-plus with a stable outlook.