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Rating agency Moody's Investors Service yesterday gave a thumbs-up on the mainland economy with positive upgrades to the ratings of both the government and the country's big banks.

Its action was in sharp contrast to a recent decision by rival agency Standard & Poor's as well as an Organisation for Economic Co-operation and Development (OECD) report this week which warned that foot-dragging over reform threatened to throw the brakes on China's economic growth.

Citing rapid growth in foreign exchange reserves, positive prospects for exports and hence the current account, and a WTO-led boost to investment, Moody's changed its outlook on the A3-rated long-term foreign currency bonds of the government from stable to positive.

The A3 rating is six notches below top-rated AAA, and as a result of yesterday's outlook upgrade, China now shares the rankings of Hong Kong and South Korea.

Yesterday's move signals a prospective change to the rating itself, which in turn would help lower borrowing costs when the government issues foreign currency bonds.

Moody's simultaneously announced a change from stable to positive in the A3 ceiling it applies to China's foreign currency bonds, as well as the Baa1 bank deposit ceiling.

Also flagged for an upward review by the agency were the Baa1 ratings it applies to the foreign currency debt and deposit obligations of China's policy banks and state-owned banks.

The outlook on these bank ratings was also changed from stable to positive, Moody's said.

'For the policy banks - China Development Bank and Export-Import Bank of China - the change in outlook reflects Moody's view that both banks will continue to receive strong government support as they discharge their functions,' it said.

'For the state-owned banks - Industrial and Commercial Bank of China, Bank of China, China Construction Bank, and Agricultural Bank of China - their Baa1 ratings reflect Moody's recognition of the implicity support provided by the government.'

This support helped offset the 'generally poor financial fundamentals' of the banks, it said.

'Moody's also believes the state-owned commercial banks will continue to receive a high level of support in the next several years as they proceed with their own reforms to privatisation.'

In contrast, S&P left its outlook rating for the mainland banking sector at stable in its latest 'Asia-Pacific Banking Outlook 2003'.

Earlier this year, S&P expressed grave doubts about the ability of China's banks to piggy-back to financial health on a strongly performing economy.

Mainland banks would need a massive US$518 billion capital injection to haul bad loans down to acceptable levels in a 'Big Bang' approach, it said.

Policy-directed loans advanced on the orders of central planners have left a mountain of unrecoverable debt on the books of China's banks - which are technically insolvent as a result.

Official estimates that the sector's non-performing loan (NPL) ratio was 30 per cent meant problem loans amounted to US$406 billion out of total lending of US$1.35 trillion at the end of last year, S&P said.

But a more realistic estimate was that up to half of all bank loans were bad, and since only about 15 per cent of these bad loans were likely to be recovered, about US$518 billion of loans would have to be written off to bring the NPL ratio down to benchmark international standards of about 5 per cent.

Meanwhile, the OECD this week warned that China's economic growth was likely to slow over the next two years. It said this prospect would arise unless the mainland authorities carried out urgently needed reforms beyond those already proposed.

The OECD also threw the spotlight on China's banking sector, recommending reforms to ensure that banks operated as 'profit-oriented commercial entities'.



Moody's upgrades China ratings