Corporate China is about to resume its deleveraging push. While debt ratios are on course to peak this year, we expect they will start dropping in 2024 and thereafter. S&P Global Ratings believes we are nearing a turning point, in which Chinese firms will only have modest appetite for borrowing-based expansion.

The result will be less growth but also less leverage. For a country that has often relied excessively on debt for economic expansion, this could be a positive shift for corporates' credit fundamentals.

We also find there are prominent splits along policy lines. Those sectors that the government has identified as worthy of support are generally targeting more expansion. Examples include the electric vehicle (EV), clean energy, and technology sectors.

Our findings are based on a survey of our analysts. We asked them to review their sectors and come up with rough indicators of whether companies are in expansion mode, or not. Their analysis mainly focuses on sectors in our rated portfolio.

Chart 1

Key Findings

Appetite for capital expenditure moderates for most

China corporates' appetite for capital expenditure (capex) is moderating. The median range of capex spending for 19 sectors is for 5%-10% growth in 2023, and 0%-5% expansion in 2024.

While the tone is broadly muted across corporate China, there are notable outliers. For example, the pandemic-disrupted capex plans of carmakers for 2022. This should lead to higher growth in 2023. EV-related capex should remain strong through 2024, and then start to taper off this high base.

The same goes from the tech sectors, with the government providing generous support to semiconductor producers in particular. This is consistent with the government's goal of making China more self-sufficient in chipmaking, particularly in the wake of U.S., European, and Japanese restrictions on the sale on advanced chips and semiconductor-making equipment to China.

Our analysts also expect power utilities to spend heavily this year on the transition to clean energy. This again is in line with policy goals, specifically for China to achieve carbon neutrality by 2060.

Otherwise, state-owned firms continue to spend heavily on infrastructure. This is a legacy of COVID. Local governments during 2020-2022 committed to large projects to support the economy.

We expect governments to maintain a somewhat stimulative fiscal stance in 2023, before gradually tilting toward a less aggressive stance (see "China Local Governments: Balancing Growth And Risk," June 5, 2023). As such, we assume infrastructure spending will fall after 2023 as the economy normalizes.

The consistent thread through these sectors is that government support makes it easier for entities to access capital. For example, China's local governments have raised about Chinese renminbi 11 trillion through issuance of special purpose bonds since 2020. Projects supported by capital from those special purpose bond are usually welcomed by financial institutions, which provide funding.

Table 1

Mergers and acquisitions moderate as firms focus on organic growth

Table 2

M&A appetite across our 19 surveyed sectors is generally low to medium for the next few years. This is consistent with our prior findings. Those firms that are in high-growth, policy-supported sectors are much more likely to seek expansion through acquisitions.

For example, firms in the tech hardware and semiconductor sector have relatively high appetite for acquiring any company with strong intellectual property.

Some entities have medium appetite for M&A, which means they are still seeking expansion but will only consider deals if exactly the right opportunity comes along, and it does not dramatically push up leverage. Such firms include those in the metals and mining, autos, consumer products, and media and entertainment sectors.

Most of the other sectors show low appetite for M&A. This is partly because they prefer to expand through internal organic growth amid a slowing economic cycle. Some sectors are also financially constrained, such as property.

Some state-owned developers could have higher appetite for acquiring projects from distressed, privately owned developers, to facilitate housing delivery and or simply to build scale. We assume state-owned developers are taking control of a reduced sector (see "China Property Is Heading For A Transformation, And Maybe A Turnaround," Nov. 20, 2022).

Debt growth outlook reflects a stance of greater caution among corporates

Table 3

We expect most sectors we cover will maintain average annual debt growth of 0%-5% over 2023-2025. This modest expansion is due to entities' more prudent approach to spending and balance-sheet management. As before, policy-supported sectors will likely be more aggressive in debt raising.

State-owned infrastructure firms are still committed to building projects planned during the pandemic, when governments viewed the works as necessary to bolster GDP. The firms will continue to raise debt to pay for this infrastructure building, in our view.

Chipmakers and other support firms will be raising debt to fund fast expansion. Semiconductors are an essential component of an array of production, including China's burgeoning EV sector. The country will be looking to replace chip shortfalls created by the export controls of the U.S. and others.

Appetite for offshore funding fades amid high interest rates in dollar-based markets

Table 4

Most sectors will rely more on domestic funding in a climate of high offshore interest rates. Most corporates will only use offshore funding this year for refinancing. Many will also use onshore funding and internal cash flow to repay offshore debt.

Companies with weak credit profiles may not find it as easy as stronger companies to access onshore funding to replace offshore funding. The firms will incur higher funding costs and higher refinancing risk as a result.

The China property sector remains quiet, but it used to generate a substantial volume of the country's dollar-bond issuance. A string of defaults makes issuance difficult for privately owned developers. State-owned property firms have ample access to domestic bond markets and bank loans, and will likely continue down that route for the foreseeable future.

Some entities, such as those in tech sectors, may issue foreign debt to fund cross-border M&A, overseas operations, or longer-term funding.

A meaningful shift

Chart 2

Entities' caution about spending in the next few years reflect moderating expectations about China's GDP trajectory and productivity growth. Company managers are also mindful of policy risks, we assume.

Companies are far less likely to borrow in offshore markets to fund a cross-border M&A, for example. This is unlike the China of a decade ago, when entities such as Fosun International Ltd., Dalian Wanda Group Co. Ltd., and HNA Group Co. Ltd. were buying a string of global assets.

Companies over the past 20 years largely focused on achieving growth through expansion, typically with use of debt. So long as prices and consumption volumes kept rising, this strategy worked.

Now, entities are typically applying more rigor to their finances and operations. Entities are paying attention to organic growth by improving cost controls, operational efficiency, and cash flow collection. They are relying less on external debt as capital sources.

Companies' more conservative approach to debt should bolster credit profiles. However, this kind of growth will require more management skill than the prior, scale-led model. Some firms will thrive, many others will be eclipsed. We assume there will be greater divergence among entities. This differs sharply from the old system, in which rising markets lifted all.

Writer: Jasper Moiseiwitsch

Related Research

• China Local Governments: Balancing Growth And Risk, June 5, 2023
• China Property Watch: Peripheral Pain, May 22, 2023
• Economic Outlook Asia-Pacific Q2 2023: China Rebound Supports Growth, March 26, 2023
• China Property Is Heading For A Transformation, And Maybe A Turnaround, Nov. 20, 2022