China's yuan jumps to strongest level in more than 3 months

Diron said China's economic recovery since late previous year was mainly thanks to policy stimulus, and expects Beijing will continue to rely on pump-priming to meet its official economic growth targets, adding to the debt overhang.

A Moody's statement said the downgrade reflected its "expectation that China's financial strength will erode somewhat over the coming years, with economy-wide debt continuing to rise as potential growth slows".

"The combination of current actions on financial deleveraging and long-term hopes on structural reforms is supportive to our cautiously constructive view on China, and is perhaps the key reason why Moody's has placed China on outlook stable after today's rating cut".

In response, senior Moody's official Marie Diron said today that the ratings agency has been encouraged by the "vast reform agenda" undertaken by the Chinese authorities to contain risks from the rapid rise in debt.

The rating agency said late Wednesday that it's lowering its local currency and foreign currency issuer ratings by one notch to Aa2 from Aa1. It then citing rising debt and uncertainty about the the government's ability to push through with reforms to ease out the economic imbalances.

SHANGHAI China plans to introduce a "counter-cyclical factor" into the way it calculates the yuan currency's reference rate each day that will better reflect supply and demand and blunt the effects of market swings.

China's total outstanding credit surged to 260 percent of gross domestic product (GDP) by the end of 2016 and the International Monetary Fund has warned that a debt crisis in the country could "imperil global financial stability".

China has strongly criticized Moody's decision, saying it was based on inappropriate methodology, exaggerating difficulties facing the economy and underestimating the government's reform efforts.

While the downgrade is likely to modestly increase the cost of borrowing for the Chinese government and its state-owned enterprises (SOEs), it remains comfortably within the investment grade rating range.

Moody's believes that the reforms may slow the pace at which debt is building up, but China's debt will not drop dramatically and it will not be enough to arrest rising debt, Diron said.

  • Zachary Reyes