Ratings agency Moody's on Wednesday cut its outlook on China's sovereign bonds from stable to negative, warning of increasing government debt and further capital outflows and questioning Beijing's ability to implement economic reforms.
The Chinese government's fiscal strength has weakened with borrowing increasing across the economy and financial system and stress mounting in state-owned enterprises, Moody's Investors Service said in a statement.
It said continued weak growth was likely to see liabilities mount at policy banks — state-owned entities that fund projects according to government instructions — as authorities pushed investment to boost economic expansion.
A negative outlook means that there is "a higher likelihood of a rating change over the medium term", Moody's says on its website — and a downgrade of Chinese bonds would push up borrowing costs for Beijing in international markets.
Government debt jumped to 40.6 per cent of gross domestic product (GDP) at the end of 2015 from 32.5 percent in 2012, Moody's estimated, forecasting it would rise to 43.0 percent by next year as policymakers increased government spending and cut taxes to support the economy.
China's economy grew 6.9 percent last year, its weakest rate in a quarter of a century, and concerns over its outlook have kept mounting.
But Moody's warned that fiscal and monetary policy support to achieve the government's economic growth target, which it expected to be set at 6.5 percent, "may slow planned reforms".
"Without credible and efficient reforms, China's GDP growth would slow more markedly as a high debt burden dampens business investment and demographics turn increasingly unfavourable," it said, adding government debt would "increase more sharply than we currently expect".
China's foreign exchange reserves, the world's largest, fell to $3.2 trillion in January, the lowest in more than three years, official data showed.
"Their decline highlights the possibility that pressure on the exchange rate and weakening confidence in the ability of the authorities to maintain economic growth and implement reforms could fuel further capital outflows," Moody's said.
But the agency kept China's credit rating at Aa3, the fourth-highest investment grade, citing the large size of buffers in the Chinese economy, including high domestic savings.
"In a largely closed financial system, buffer erosion would most likely be gradual, providing time to address key areas of reform," it said.