Chart 1

Slowing GDP growth, falling land sales, COVID lockdowns, and looming maturity walls are increasing the pressure on China's local government-related entities (GREs). S&P Global Ratings believes these factors will compel local governments to be increasingly selective in extending support and could raise ratings volatility for weaker GREs in 2022.

Ratings Have Stabilized, With A Modest Negative Bias

Since our last China GRE List report in September 2021, we revised outlooks or ratings on four Chinese GREs, including three positive and one negative actions (see table 1). This is on the low side for a six-month period. In contrast, we took 25 rating actions on 18 GREs in the first nine months of last year and 18 rating actions on 11 GREs in 2020.

Stabilizing credit conditions past the peak of the pandemic help explain the general stabilization.

Table 1

While 90% of our GRE ratings carry stable outlooks, the portfolio has a slight net negative bias (see chart 2). Some 8% of ratings have negative outlooks versus 2% with positive outlooks. The net 5.7% bias is more negative than the 4.4% in September 2021. Our outlook bias is derived by subtracting positive from negative outlooks and CreditWatch statuses, and dividing the balance by the number of ratings outstanding.

Chart 2

Entities with negative outlooks include three corporates and four financial institutions (see table 2).

Table 2

Correlation Driven by Government Policy Not Sectoral Forces

As of April 25, 2022, we rated 87 GREs in China, including 47 controlled by the country's central government and 40 controlled by local and regional governments.

The largest sector in our rated portfolio is nonbank financial institutions (17 issuers), followed by banks (12), utilities (10), and engineering and construction entities (6). The remaining issuers are dispersed across a diverse range of industries from commodities to industrial and consumer sectors (see chart 3).

The central government's recent tightening on fiscal, debt, and GRE risks across the country's localities led to better central management and enhanced local discipline. This drove increasing selectivity in government support and led us to take rating actions on several financial and corporate GREs across a number of sectors (see "Institutional Framework Assessment On China's Local Governments Raised On Central Government's Tightening Control," published Aug. 30, 2021, on RatingsDirect).

Chart 3

Local GREs Have Weaker Credit Profiles

Among central GREs, the largest rating concentration within our rated portfolio is in the 'A' rating category ('A+' to 'A-'), which has more than three times the number of issuers than the 'BBB' rating category ('BBB+' to 'BBB-', see chart 4).

The reverse is true of local GREs, where the number of issuers within the 'BBB' rating category is more than double the number of issuers within the 'A' rating category.

Chart 4

Based on our rated portfolio, central GREs in China tend to have stronger stand-alone credit profiles (SACPs) than local GREs (see chart 5). Some 57% of central GREs carry SACPs of 'aa' to 'bbb', while only 15% of local-government GREs show similar stand-alone credit strengths. Notably, one out of eight local GREs show SACPs below 'bb' while none do among the central GREs, indicating a greater vulnerability to fundamental risks at the lower end of the credit spectrum.

Chart 5

Ratings on central GREs also incorporate less government support. Over half of our ratings on central GREs receive either no benefit, or just a one to two-notch uplift for government support, whereas only 40% of local GRE ratings incorporate similar levels (see chart 6).

At the other end of the spectrum, no ratings on central GREs received more than five notches of uplift for government support, whereas 10% of ratings on local GREs incorporated support at those levels.

Chart 6

Pressures Are Increasing

The distribution, makeup and trends of our China GRE ratings suggest more vulnerability among local government-linked GREs against coming headwinds.

We recently revised down our forecasts for China's home sales to a 15%-20% drop this year, from a prior expectation of a 10% decline. This, as well as renewed COVID lockdowns, will weigh on the government's ability to meet its "around 5.5%" GDP growth target. Our base case is that the Chinese economy will expand 4.9% this year (see "Asia-Pacific Economic Risks, Thy Name Is Inflation," March 28, 2022).

Amid the slowdown, local governments are likely to face a 20% drop in land sales in 2022. As a result, their fiscal positions will either remain stretched or deteriorate further. This should encourage more spending discipline and push more selectivity in extending support to local GREs.

Many localities will also face daunting maturity walls, as about US$1 trillion-equivalent of domestic bonds will be coming due in 2022-2023. While most local and regional governments (LRGs) will have a range of funding options, the sheer volume of maturities may test more indebted LRGs and their GREs in lower-income regions.

Although we do not expect broad credit deterioration over the next 12-18 months, a select few could fall into distress. Recent cases have shown that such an event could disrupt market access for the government owner of the GRE in question, or for other GREs owned by that locality.

The recent default of Lanzhou City Development Investment Co. Ltd. reflects some of these stresses. This and other cases are pushing further credit polarization and leading lenders and investors to favor GREs of more financially robust local governments, typically those of higher-tier cities or provinces. This could sow the seeds of distress among entities not designated for state support, particularly as growth slows and headwinds intensify in the coming year.

Appendix

Table 3

Table 4

Table 5

Chart 7

Chart 8

Editor: Jasper Moiseiwitsch

Digital design: Evy Cheung

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