Moody's downgraded its outlook on Chinese government debt to "negative" from "stable", citing uncertainty over authorities' capacity to implement economic reforms, rising government debt and falling reserves.
The Moody's downgrade comes just days before the National People's Congress is due to vote on China's 13th five year plan, a closely held development blueprint for the next five years.
Analysts will closely scrutinise the NPC's final text for hints on the likely trajectory of reform and policymakers' thinking on the appropriate growth strategy for China - key factors highlighted by Moody's in the report issued today.
"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," Moody's said.
"Government debt would increase more sharply than we currently expect," it added.
The agency said its rating committee had discussed China's status at a meeting on February 9, during which the country's institutional and fiscal strength, as well as its susceptibility to event risk, were reviewed.
The agency said the downgrade was driven by expectations that China's fiscal strength will continue to decline, as well as the fall in its foreign exchange reserves which have shrunk by $762 billion over the last 18 months.
It also said that policymakers' credibility was at risk of being undermined by incomplete implementation or partial reversals of some reforms.
"Interventions in the equity and foreign exchange markets over the past year suggest that ensuring financial and economic stability is also an objective, but there is considerably uncertainty about policy priorities," the agency said.
Moody's, however, retained China's Aa3 rating, noting the country's sizeable reserves gave it time to implement reforms and gradually address economic imbalances.
But the agency warned that it could further downgrade China's rating if it saw slowing down of reforms needed to support sustainable growth and to protect the government's balance sheet.
In a separate note today, ratings agency Fitch also highlighted rising risks to Chinese banks from accelerating credit growth.
"The cut to the reserve requirement ratio (RJR) for Chinese banks on Tuesday, together with record loan growth in January, could point to an increasing likelihood that the authorities are shifting policy to enable more credit-fuelled growth," Fitch analysts wrote.
"Rolling over more debt will only delay and not resolve an expected rise in non-performing loans," it added.
The People's Bank of China yesterday cut bank reserve ratio requirements by 50 basis points, releasing an estimated $100 billion of cash for lending.
