The agency lowered China's long-term local currency and foreign currency issuer ratings to A1 from Aa3, but said its outlook changed from "negative" to "stable".
"While ongoing progress on reforms is likely to transform the economy and financial system over time, it is not likely to prevent a further material rise in economy-wide debt, and the consequent increase in contingent liabilities for the government", it added. The downgrade comes nearly 15 months after Moody's placed China on negative outlook on March 2, 2016. Not great, according to one of the world's top credit rating agencies.
The news triggered an early selloff in Chinese stocks, with shares in Shanghai SHCOMP, -0.36% falling more than 1% before recovering, in addition to modest losses for the Chinese currency in the freely traded offshore market. "However, S&P has China one notch higher on AA- with a negative outlook since 31 March 2016.", they say.
Chinese stocks and commodity futures, along with the Australian dollar, have also come under selling pressure today.
Moody's has Japan at the same A1 rating China is now on. Fitch's current rating for the country, A+, is its fifth-highest.
The agency said capital formation in China is expected to slow as investments have a lower share in total expenditure.
At the same time, China's external debt is low by worldwide standards, at around 12% of gross domestic product, according to the global Monetary Fund, meaning that a downgrade isn't likely to be as disruptive as it would be for nations more reliant on global funding.
Moody's has no specific timetable for re-visiting China's rating, but would monitor conditions on a regular basis, said Marie Diron, associate managing director of Moody's Sovereign Risk Group.
"This is like throwing cold water when everyone is optimistic about China's economy".
Chinese stocks sank Wednesday after Moody's cut the country's debt rating and other Asian markets rose following Wall Street's advance.
China's economy grew 6.9% in the first quarter of this year, picking up the pace from the end of 2016. Growth hit 10.6 percent in 2010 before sliding to a near-three decade low of 6.7 percent previous year.
The agency warned that China's economy-wide debt is expected to rise further over the coming years while the government's direct debt burden rises to 45 percent of the economy by 2020 from about 40 percent in 2018.
Julian Evans-Pritchard, China Economist at Capital Economics in Singapore, said steps to resolve the debt overhang, such as debt-for-equity swaps at state-owned enterprises, were insufficient to deal with problem. The erosion in China's credit profile will be gradual and, we expect, eventually contained as reforms deepen.