Can China prove Moody’s wrong and tackle its growing debt mountain?

However, most of this debt is domestic, owed by state owned enterprises, local government and private corporations to Chinese state-owned banks. As a result, the government disagreed with Moody’s analysis, saying it was based on inappropriate methodology, exaggerated the difficulties facing the economy, and underestimated the government’s reform effort. 
The government has very little foreign debt, extensive official reserves, and could absorb much of the debt if necessary.
Moody’s responded that it had been encouraged by the “vast reform agenda” undertaken by China to contain risks from debt, but reiterated its concerns, saying it does not believe the trend will change or that levels will drop dramatically. 
Moody’s is also concerned that the government will increase spending to meet its growth targets which will add to the debt, not reduce it.
Although the Chinese government has policies to reduce the country’s debt burden, the process is slow and difficult. It plans to reduce capacity in the heavy industrial sectors dominated by state-owned enterprises, such as steel and coal, but this will eliminate jobs of low-skilled workers, reduce the tax base in municipalities, and cause economic contraction. Even though Beijing has been trying to do this for more than a decade, the capacity in these two sectors has doubled during this time. 
To replace the old industries, the government wants to move to high-end manufacturing and is encouraging advanced technologies, innovation and consumption-driven growth. It has had some success in this – services now count for more than half of the economy and high-tech manufacturing is expanding rapidly. However, this kind of economic development takes time and it’s unlikely to be fast enough to replace the jobs taken out of the old economy. 
Moreover, monetary policies are also putting a brake on the economy as the central bank is tightening liquidity, expanding financial regulation and increasing interest rates. Moody’s concern is therefore understandable, given the government’s commitment to keeping economic growth at a relatively high level.
To reduce debt Beijing is reforming local government fiscal systems while tightening regulation of financial instruments such as wealth management products which have been propping up the shadow banking system. Of course, this adds to the delicate balancing act as it may create pressures on the financial system and markets.
Later this year the 19th Party Congress is expected to consolidate the leadership of Xi Jinping and Premier Li Keqiang. It will be interesting to see if any new directions emerge after this.