Moody's decision to lower China's credit rating to A1 from Aa3 reflects Moody's expectation that China's financial strength will "erode somewhat over the coming years".
Economy-wide debt in China is continuing to rise as "potential growth" slows, said the ratings agency.
The downgrade, which is the first for China since 1989, was quickly dismissed by the government's finance ministry.
"Moody’s views that China’s non-financial debt will rise rapidly and the government would continue to maintain growth via stimulus measures are exaggerating difficulties facing the Chinese economy," said the ministry in a statement.
"[Moody's] is underestimating the Chinese government’s ability to deepen supply-side structural reform and appropriately expand aggregate demand."
Commenting on the downgrade, PineBridge Investments co-head of Asia fixed income Arthur Lau said the decision was not a shock, given Moody's downgrade of China from 'neutral' to 'negative' in March.
"However, the timing of the rating reduction has taken the market by surprise, and we believe that S&P may follow suit," Mr Lau said.
"Chinese credit has opened wider and we believe that it may underperform in near-term, as the onshore tightening process has only just begun.
"For the offshore bond market, we do not think there will be many changes, partly due to the expected supply of lower credit quality sector."