China stocks steady, small-caps offset Moody's downgrade

The blue-chip CSI300 index <.csi300> was unchanged at 3,424.17 points, while the Shanghai Composite Index <.ssec> added 0.1 percent to 3,064.08 points.

Moody's Investors Service downgraded China's long-term local and foreign currency issuer ratings on Wednesday, citing expectations that the country's financial strength would erode in coming years as economic growth slows and debt continues to mount.

The benchmark stock indexes fell more than 1 percent shortly after the market opened, but recouped most of the losses to close roughly flat.

The downgrade has had "a negative psychological impact on the market," said Tian Weidong, strategist at Kaiyuan Securities, adding Beijing's campaign to clean up the financial system was already driving up market rates and sowing panic among retail investors.

The market has already been hobbled in recent weeks amid signs that Beijing's regulatory crackdown on shadow banking and risky investment is pushing up short-term borrowing costs and threatening to slow the economy.

In a rare sign of tightening liquidity in the interbank market, the one-year Shanghai Interbank Offered Rate (SHIBOR) was at 4.322 percent, exceeding the one-year Loan Prime Rate at 4.3 percent.

Morgan Stanley said in a report on Wednesday that China's interbank interest rates can rise by another 40-50 basis points from current levels in the coming months, to keep pace with the U.S. Federal Reserve's tightening moves.

Most sectors lost ground, led by defensive consumer <.csi300cs> and healthcare stocks <.csi300hc>.

Small-caps rallied strongly, with the tech-heavy start-up board ChiNext <.chinextp> rising 1.0 percent.

(Reporting by Luoyan Liu and John Ruwitch)