The decision by Standard & Poor's to downgrade the mainland's sovereign rating has stunned investors. Certainly, some kind of action was expected, given S&P's negative outlook, and the balance of probabilities always had pointed to a downgrade, but S&P's decision has caused more concern because of the reasons it has given for its action. Its statement that the downgrade 'reflects lower trend growth prospects and rising fiscal costs of economic reforms', is surely nothing new and hardly a reason to worry financial markets. The fact that Moody's Investors Service and Fitch IBCA have both turned round and said they plan no change themselves on mainland ratings demonstrates that S&P's concerns are not shared by its peers. Even market reaction has been relatively muted. Bonds widened predictably, but traders reported no mass selling. What seems more likely to be the case for the S&P move is that the agency is still smarting from the stinging criticism it and all the other large credit-rating groups faced following the outbreak of the Asian financial crisis in 1997. Their failure to mention or, even worse, spot growing problems in Asian economies was widely lambasted, and even prompted Fitch IBCA at the time to publish an unprecedented explanation of why it had failed to warn investors about emerging weaknesses in South Korea. Many now believe that S&P, aware that the mainland still has the potential to disrupt the economic recovery in the region, is eager to move as soon as it has some concerns, regardless of how valid they are. One foreign-exchange analyst even noted yesterday that the first point of contact on S&P's press release was to a US-based employee, sparking speculation that the agency's top management may have had more of an influence than usual in crafting the downgrade. The lower trend of growth prospects that S&P says it is worried about has been a feature of the mainland economy ever since growth peaked at 14.2 per cent in 1992. If concerns over overheating have given way to a real fundamental economic slowdown, it still has to be viewed in light of the fact that, even if the mainland hits only 7 per cent growth this year, this is still much higher than can be claimed by many other economies in the world. The rising fiscal costs of the mainland's economic reforms, most visibly seen in the huge pump-priming measures that Beijing has embarked upon since the beginning of 1998, are also highlighted by S&P as a worrying issue. Yet this is also no surprise to investors, and with the mainland's current account expected to remain in small surplus this year and with an approximate ratio of short-term debt to foreign reserves of about 13 per cent, Beijing seems to have more than enough resources to see it through its planned heavy expenditure. In this regard, one concern might legitimately be the future burden the mainland is piling itself up with through the numerous domestic bond issues used to help finance its infrastructure investment. But this is a problem that seems to be dwarfed by the one issue that is not even mentioned in the S&P downgrade - deflation. The real threat to the mainland's economy comes from the continuing propensity among the population to save, refusing to trust Beijing's exhortations to spend, which is generating a downward spiral in prices. Japan's experience of the damage that such a trend can wreak on an economy points to the scale of the threat to the mainland economy. With retail prices down about 3.4 per cent, the government has a real problem that is in danger of spiralling out of control. So far, efforts to prevent further deflation have been ineffective, and, as the domestic population's faith in the economic management of the government wanes, then the credibility of the yuan's exchange rate becomes shakier. S&P may have been right to downgrade, and it may prove to have the last laugh on its rivals, but its decision to lower the mainland's ratings has been taken for the wrong reasons.