Chart 1

The government-linked sector in Southeast Asia and India is back in the spotlight. After a decade of steady economic growth, ample funding availability, low interest rates and rising leverage, defaults and restructurings at state-owned enterprises (SOEs) and government-linked companies (GLCs) have picked up. S&P Global Ratings expects credit quality in the state-owned sector to stay polarized over the next three years between entities most critical to government policy goals and the smaller, less strategic (and often more leveraged) SOEs and GLCs. For the latter, debt restructurings are likely to remain a feature as government support becomes increasingly selective.

To be sure, some large and critical SOEs that we rate have either strengthened their balance sheet or maintained solid balance sheets throughout the period. That's the case for the large national oil companies such as Pertamina (Persero) PT in Indonesia, Malaysia-based Petroliam Nasional Bhd. (Petronas) and India-based Oil and Natural Gas Corp. Ltd. (ONGC).

There may also be mitigants to rising leverage. These could include diversified funding sources, a resilient business model and, perhaps more importantly, the willingness of governments to provide timely support if the situation worsens beyond a threshold.

Yet, high and fast rising leverage may point to less robust government monitoring or an expectation by the government that the state-owned firm has to deal with its own financial situation. This may especially be the case for the smaller entities that play a lesser role in the economy and where most of the leverage growth has taken place.

In this primer, we aim to provide insights on operating, balance sheet, liquidity, and trends in government support for the state-owned sector in the region. We selected 77 SOEs and GLCs as a starting point. These companies are often among the largest, most diversified entities in their sectors, and often of their country. We believe they represent broader credit trends and government behavior toward domestic state-owned sectors.

Chart 2

Chart 3

The Current State Of Balance Sheets At Regional SOEs And GLCs

Our survey indicates that leverage and credit polarization are on the rise again after a short post-pandemic reprieve (see chart 4). The median ratio of gross debt to EBITDA of those companies is creeping back up to about 5x based on the latest reported financials. That's below the highs of the pandemic (about 6x) amid a recovery in earnings, but still nearly double 2017 levels (2.8x). Median EBITDA interest coverage ratios (at slightly over 4x) have also eroded but been generally more resilient thanks to an extended period of low funding costs.

The debt growth is spread across countries and most sectors outside the commodity and energy space. Gross debt increased by over 50% for half of the companies reviewed between 2017 and the latest 2023 interim reports, about three times faster than earnings growth.

Levels also appear sticky. Reported debt stands at about US$400 billion in aggregate currently. The figure is more than US$100 billion greater than in 2017, and close to the pandemic highs of about US$405 billion in 2020 as most companies reinvested improving cash flows post-pandemic rather than repaying debt.

Chart 4

Balance sheets are becoming increasingly polarized. The trend has been developing since the middle of the past decade given steady capital spending and inexpensive debt. The number of SOEs and GLCs we reviewed with a ratio of gross debt to EBITDA exceeding 4x nearly doubled from 2017. The ratio exceeded 5x for about 40% of 77 companies we reviewed, up from about 30% in 2017 (see chart 5).

On a net-debt basis, the proportion of SOEs and GLCs with a net debt-to-EBITDA ratio exceeding 5x climbed to about one-third compared with about one-fifth in 2017. The number of companies with conservative capital structures, or a ratio of gross debt to EBITDA of less than 2x, dropped to 16 from 24.

Chart 5

The growing polarization of capital structures hide otherwise consistent financial policies at individual companies, especially at both ends of the leverage spectrum (see chart 6):

• Thirty-two companies have consistently maintained either conservative or more leveraged capital structures.
• Leverage increased at 30 companies.
• Leverage decreased at 15 companies.

Of the companies that increased leverage, the sharpest erosion in balance sheets was due to a few key factors. First, operating conditions or reduced mobility weakened for companies such as airport operators Airports of Thailand Public Co. Ltd. and Angkasa Pura I PT, and Indian engineering company Bharat Heavy Electricals Ltd. Second, some companies maintained steady investments or acquisitions, such as power producer Ratch Group Public Co. Ltd. and services company Singapore Airport Terminal Services Ltd. And, finally, there was a combination of these factors for refinery and chemical companies Thai Oil Public Co. Ltd. and PTT Global Chemical Public Co. Ltd., or construction companies Wijaya Karya (Persero) Tbk. PT and PP (Persero) Tbk. PT.

Over a third of the companies that improved their capital structure operate in the commodities sector. Capital structures strengthened on resilient demand and moderating capital spending at UMW Holdings Bhd., Telekom Malaysia Bhd., and Power Grid Corp. of India Ltd. Debt reorganization likewise assisted Thai Airways International PLC.

Most SOEs or subsidiaries of SOEs that we rate (13 out of 22) have either strengthened or maintained similar leverage levels over the past five years, most of which in the energy, commodities and power generation sectors.

Chart 6

The Countries And Sectors Where Leverage Has Climbed Fastest

The main drivers of leverage vary across countries. In Indonesia, it's generally an outcome of steady spending and acquisitions across sectors amid otherwise resilient operating performance. In Singapore and Thailand, it is typically the result of a lackluster profit recovery post pandemic, steady capital spending, and sticky dividends.

Gross leverage nearly doubled at the reviewed SOEs in India but from a low base, largely because of capital spending. Leverage at Malaysian SOEs has been flat, thanks to controlled capital spending and higher product prices for commodity SOEs.

Chart 7

From a credit standpoint, we generally look at capital structures on the basis of net debt (not gross debt) when an issuer has more predictable earnings. Predictable earnings often reduce large swings in liquidity. In the region, we observe predictable earnings when issuers have:

• Asset, product, geographic, and customer diversity;
• A record of above-average industry margins;
• Solid and sustainable domestic or regional market share; or
• Solid operating efficiency and working capital management.

Net leverage may be a better indication of credit quality for some of the larger SOEs or GLCs in the region, given their greater size, market position, diversity, and operating efficiency versus their private counterparts.

Capital structures appear slightly less leveraged on a net basis (see charts 8 and 9). Netting cash reduces the ratios of debt to EBITDA by about 1x, on average. The SOEs we reviewed in India and Malaysia tended to hold more cash than their Thai, Singaporean, and Indonesian counterparts, nearly halving gross leverage levels.

Chart 8

Chart 9

Leverage has edged up in most sectors since 2017 (see chart 10). Median net leverage almost tripled in the construction and real estate sector (noting a sample bias toward a large number of highly leveraged construction companies in Indonesia). It has also nearly tripled over the 2017 level at industrial SOEs. The gap is largely due to expansionary capital expenditure (capex) at heavy manufacturing SOEs or subsidiaries of SOEs.

Net leverage has nearly doubled in the transportation and consumer sectors over the past five years but with different post-pandemic trends: a sharp leverage improvement in the transportation sector amid a recovery in mobility, an acceleration of leverage in the consumer sector amid lackluster earnings growth and persistent spending.

Two sectors stand out. First, power and utilities where net leverage has remained broadly stable due to resilient demand and the ability to pass some or all rising fuel costs. This helped offset steady capital spending at most power SOEs. Second, in the commodities sector, median net leverage has dropped to the low levels of 2017. Unlike in previous expansionary cycles, financial discipline at these companies appears to be more entrenched, with firms either accumulating cash or applying excess cash flows to debt repayment.

Chart 10

Leverage Is Likely To Creep Up

The profit environment is more muted

The bulk of the recovery took place in 2021 (for commodity SOEs and some industrial sectors) and in 2022 (for mobility and infrastructure sectors). Since then, with the exception of power utilities, profit momentum has been slowing across the companies we reviewed (see chart 11).

We see few catalysts for an acceleration in earnings momentum heading into 2024 for the companies we reviewed. Prices of most metals and minerals are reverting to mid-cycle levels as China growth decelerates and economic conditions stay soft in Western Europe and the U.S. This will primarily hit the earnings outlook of commodity and industrial SOEs.

The pace of the recovery is slowing in mobility sectors--especially airports--compared with the past two years, noting we still expect a reversion to pre-COVID levels by 2025. Rising interest rates will also bite gradually, but aren't typically a significant component of most SOEs' profit and loss statements. This is will be more likely will be especially the case in comparatively more leveraged sectors such as construction, real estate, and power utilities, and power/utilities without contractual interest costs pass-through.

Chart 11

The earnings momentum appears more solid for SOEs in India heading into 2024, on the back of stronger GDP growth compared with other countries in the region (see chart 12). Industrial activity, electricity consumption, and trade and customer traffic are now exceeding pre-pandemic levels on healthy momentum. Unlike in Malaysia or Thailand, the Indian government has also allowed commodity and electricity producers to pass through higher input costs to end-consumers on a timely basis. This limits the effect of cost inflation on profits.

Chart 12

Outflows are likely to resume

Negative discretionary cash flows will likely continue to widen over the next three years, to make up for sharp cuts to spending and dividends in 2020 (see chart 13).

Company-level capital spending increased by an average of 15% in 2022 over 2020, after dropping by an average of about 28% between 2019 and 2020.

Accelerating capex also seems to be a widespread phenomenon--about two-thirds of the 77 reviewed companies raised capex 2021-2022. The trend was especially apparent for the following sectors:

• commodities (reserve replenishment, energy transition)
• industrials (downstream capacity expansion); and
• power and utilities (capacity expansion and investments in energy transition, especially in Indonesia, Malaysia, and Thailand).

Chart 13

Company-level capital spending increased by an average of 15% in 2022 over 2020, after dropping by an average of about 28% between 2019 and 2020.

Accelerating capex also seems to be a widespread phenomenon--about two-thirds of the 77 reviewed companies raised capex 2021-2022. The trend was especially apparent for the following sectors:

• commodities (reserve replenishment, energy transition)
• industrials (downstream capacity expansion); and
• power and utilities (capacity expansion and investments in energy transition, especially in Indonesia, Malaysia, and Thailand).

By contrast, over 70% of companies reviewed had cut investments in 2020 amid the pandemic.

We also anticipate a pick-up in shareholder distributions as earnings stabilize and dividend payouts revert to pre-pandemic levels. As of the latest reporting period, over half of the 77 entities reviewed still paid lower dividends in 2022 than in 2019, despite a recovery in earnings.

Funding Is Still Available, But Is More Selective

Most of the large regional SOEs and GLCs we reviewed have above-average liquidity compared with domestic private companies. Their often large size affords them better access to domestic funding sources, especially to state-owned banks and financial institutions (see table 1). The firms also have a longer record of accessing domestic bond markets and better funding diversity.

Table 1

A government-linked status sheltered most entities from the recent volatility in capital markets, notwithstanding rising funding costs. Only about one-third of the 77 companies we reviewed had exposure to foreign-currency capital markets (generally through U.S.-dollar bonds). Those having a higher share of foreign-currency bonds also benefit from:

• a sizable cash balance (Pertamina (Persero) PT and Petronas);
• improving cash flows or profits (PLN, Mineral Industri Indonesia (Persero) PT);
• stable cost and interest pass-through provisions (for most regulated utilities); or
• solid backing from their government-owned parent (PTT Global Chemical, PTT Exploration and Production Public Co. Ltd., and Thai Oil).

Longer debt maturity profiles are a key credit strength of the sector compared with private companies, amid rising rates and funding selectivity. We estimate the median ratio of short-term debt to total debt at 18% based on the reported data of the past 12 months. The average debt tenor is four to five years across the companies reviewed (five to seven years in Thailand and Malaysia), about twice the average of the private sector (see chart 14).

Unlike private companies that tend to keep a fairly high share of short-term debt (especially post-pandemic), SOEs and GLCs managed to lengthen their debt maturity profile in all countries reviewed except in Singapore.

Chart 14

Liquidity and refinancing risk appear manageable for most of the 77 companies we reviewed (see chart 15). Five of the 10 companies using predominantly short-term funding had conservative balance sheets, mitigating refinancing risk. We view companies with over 25% of short-term debt in their funding mix and a net leverage exceeding 5x as more exposed to refinancing risk, even if their SOE or government-linked status may facilitate fundraising.

Chart 15

That is not to say that funding is indiscriminate. Domestic banks will be prompted to be more selective in their lending, given the rapid deterioration in the credit profiles of some companies, and the recent defaults and restructurings of SOEs and their subsidiaries--most notably in Indonesia. We also believe credit providers will scrutinize the strength of government linkages more closely when entities tap foreign-currency markets.

The Challenge Of Rising Rates

We don't see a systemic risk from rising rates on Southeast Asian and Indian SOEs or GLCs because their reliance on short-term funding has reduced (see chart 15 above). The aggregate effect on operating cash flows, while negative, is also likely to be moderate and manageable.

By our estimate, the aggregate interest expense across the 77 SOEs or GLCs we reviewed could increase by about 25% (about US$5 billion) in 2024. This figure assumes an average 300 basis point increase in funding costs on refinanced short-term debt and new debt raised to fund negative cash flows.

Assuming interest rates stay at the current levels, aggregate interest expense for the companies reviewed is likely to rise by US$4 billion-US$5 billion annually for the next few years as companies refinance maturing debt or raise capital at more expensive levels. We estimate 20%-25% of total gross debt on average matures each year over 2024-2026.

The credit impact is largely company-specific; rising rates in themselves have not been the primary driver of SOE defaults or restructurings in the past three years. Median EBITDA interest coverage drops the most at Indian SOEs (over 2x) under a higher-interest-rate scenario given their higher reliance on short-term debt versus regional peers.

The effect is less pronounced for companies in Malaysia, Singapore and Thailand, given generally longer debt tenors. Sector-wise, SOEs reliant on working capital in the construction sector are likely to be the most affected by rising rates (chart 16).

Chart 16

The Main Lessons From Recent Defaults And Bailouts

The recent debt restructuring and defaults at regional SOEs provide useful insights. They guide us on the drivers of defaults and restructuring, the context, and government attitude to its state-owned sector.

Lesson 1: Government support has been selective.  Little government support has been needed in the region since the global financial crisis, given steady economic growth, cheap and available debt funding, attractive returns on investment, and conservative capital structures. While there were occasional bailouts, the willingness of regional governments to provide more systematic support was not tested. Rising defaults and restructuring across the region since 2018 suggest that government support has been, and will continue to be, highly selective.

Lesson 2: The economic impact of SOEs and GLCs defaults or debt restructurings has been limited.  SOEs and GLCs often continue their operations amid default or restructuring with minimal disruption to the wider economy. Flagship airlines in Indonesia, Malaysia, and Thailand have maintained operations in such circumstances, albeit at reduced capacity. Work on critical infrastructure and steel production continued in Indonesia during debt restructuring at two of the largest state-owned Indonesian engineering, procurement, and construction companies, and at domestic steel producer Krakatau Steel (Persero) Tbk. PT. This fact could tilt governments toward providing enough support to maintain operations rather than providing funds to support timely debt servicing.

Companies in the real estate, construction, transportation infrastructure, upstream mining and agribusiness are most likely to continue operating through restructuring or default in our view. That's because they generally have little reliance on foreign inputs or technological knowledge. A default will more likely hit the operations of large energy companies or electricity providers by affecting their ability to import fuel or raw material. That would have lasting repercussions for the economy and, as such, would be more likely to draw preemptive government support.

Lesson 3: A complex ownership or corporate structure can delay support.  Stress must be identified or anticipated sufficiently in advance, which can be more difficult in complex structures. It may not be clear who within the group will provide support (the parent company, a sister SOE, or the government). Support must also be provided quickly when needed. Related-party transactions between an SOE parent and a subsidiary such as equity raising and asset sales may require support from minority shareholders, delaying such actions.

We believe the issue of complex ownership will become more acute for Indonesian SOEs in the next few years. The drive to amalgamate SOEs there into large and complex industrial silos is creating multiple holding and sub-holding layers. At the same time, each amalgamated SOE typically maintains operating, financial and--sometimes--fundraising independence from the group, and may still have minority shareholders.

To be sure, the largest SOEs in Indonesia such as Pertamina are putting in place more robust oversight to monitor group companies. They are strengthening financial transparency and reporting within the group while codifying support mechanisms between the parent company and sub-holdings or listed subsidiaries. But those mechanisms are recent and have not yet been tested in the context of stress, especially for those SOEs that plan to equitize part of their previously fully-owned subsidiaries.

Large energy SOEs in Thailand (PTT Public Co. Ltd.) and in Malaysia (Petronas) have time-tested support between the parent company and group subsidiaries or associates, in our opinion. Oversight is sound and there are well-established mechanisms to identify and cure liquidity needs at group companies. Both parents have acted as a backstop provider of liquidity during previous industry cycles or periods of deterioration at their most important subsidiaries through cash-pooling mechanisms or credit or working facilities that can be employed across the group (see table 2).

Central or concentrated ownership generally makes support timelier. In this regard, we see the concentrated ownership of most Singapore government-linked companies as a credit strength. Note that this does not mean that timely government support will be forthcoming for entities fully owned by their government. Agribusiness company Perkebunan Nusantara III (Persero) PT and social-housing company Perusahaan Umum Pembangunan Perumahan Nasional defaulted or restructured their debt obligations despite being fully owned by the Indonesian government.

Table 2

Lesson 4: Watch for mechanisms of support.  Governments may publicly claim it will support a strategic sector or company but lack the administrative capacity to do so in timely fashion. Funding may not be available and the government may need to free up budget and go through parliament for approval, a potentially time-consuming process. Government support may come with conditions attached, such as earmarking funds for specific purposes or be provided after restructuring.

Funding through state-owned banks or ad hoc equity injections earmarked for specific projects are generally less firm and timely forms of support in Southeast Asia and India. That's because even state-owned banks need to pull funding together and go through due diligence and a credit process. Some state-owned banks may also have to observe maximum loan concentration requirements.

Government support may not solve immediate liquidity or solvency issues if funds are not available for debt payment. The Indonesian government used both methods over the past decade at construction, mining, agribusiness, and airline SOEs without always solving liquidity or solvency stress. A wave of defaults and debt restructurings followed nevertheless.

On the other hand, unconditional debt guarantees and a record of timely government transfers are two stronger mechanisms. The Indonesian government strengthened the timeliness of the compensation and subsidy payments mechanisms to electricity producer PLN and energy company Pertamina over the past two years.

Unconditional government guarantees are increasingly rare in the region, but still employed on an ad hoc basis. The Malaysian government took over some of the liabilities from investment company 1MDB while the Indonesian government guarantees part of the debt of construction company Hutama Karya Persero PT.

The emergency recapitalizations of nonfinancial entities are rare in the region. Those that staved off default anticipated the stress, implemented comprehensive remedies, and were backed by well-funded and committed shareholders. That was the case of Singapore Airlines Ltd., which raised a massive Singapore dollar 15 billion within a few weeks in 2020, in part to reduce liquidity stress.

Lesson 5: Restructurings have generally involved immediate liquidity relief and more rarely leverage reduction.  Regional SOEs in restructuring rarely impose comprehensive haircuts of debt or financial obligations. Except for airline companies Garuda Indonesia (Persero) Tbk. PT and Thai Airways, most restructuring packages so far have involved maturity extensions and lower interest rates. We believe one of the reasons may be not to overly burden the asset quality and capitalisation of domestic banks. The absence of principal haircuts among SOEs whose capital structures are unsustainable means repeated restructurings are likely. A good example is the case of Indonesia's Waskita Karya (Persero) Tbk. PT. The state-owned construction firm has undergone multiple rounds of debt restructuring since 2021.

The Types Of Entities Most Likely To Draw Government Support

When rating government-related entities, we use a matrix approach designed to focus on two parameters: the importance of the GRE's role to the government, and the link between the GRE and the government (See "General Criteria: Rating Government-Related Entities: Methodology And Assumptions," March 26, 2015). Combined, these two factors help to assess the likelihood of extraordinary government support. The factors are not necessarily equally weighted, as described in the matrix below (see chart 17).

Chart 17

In our rated universe, we assess four companies (Pertamina, PLN, Petronas, and Sarawak Energy Bhd.) as the most likely to obtain timely government support if they required it. These four operate critical energy or power infrastructure and provide a key public service that could not be readily undertaken by a private entity.

A default would likely be a major reputational hit for the government and entail widespread economic consequences, given the firms are generally large domestic or provincial monopolies and often among the largest domestic borrowers in foreign currency. The four entities are all fully owned by their government, with well-tested support mechanisms, clear and robust processes and procedures in place that enable effective governance, monitoring and control (see chart 18).

We equalize the issuer credit rating on these four entities to that of their government owners. Indonesia-based Pertamina and PLN and Malaysia-based Sarawak Energy benefit from one, five, and seven notches of uplift from our stand-alone credit profile (SACP), respectively. We regard Malaysia-based integrated oil and gas company Petronas as having stronger stand-alone credit characteristics than the Malaysian sovereign given its very conservative funding structure. Our rating on Petronas is capped at the sovereign level because of the government's record of drawing on Petronas' resources for its budget, including via additional dividends.

Chart 18

Entities operating in competitive sectors or those with commercial orientations and whose activities can be undertaken by another entity (Axiata Group Bhd., Singapore Telecommunications Ltd., or Telekom Malaysia) are less likely to receive government support. Companies in between operate important or very important infrastructure, in sectors that are not fully competitive, and their defaults would generally have significant systemic impact on the local economy.

Rating uplift from SACPs tends to be more modest for companies that either have solid SACPs to start with, or which are less important or with otherwise less robust ties to their government (see table 3).

Table 3

SOEs And GLCs Are Here To Stay

Despite rising leverage, SOEs and GLCs remain key conduits of economic policy in the region. They deliver both quick economic relief--most recently by limiting inflationary pressure for consumers--and act as critical agents in the region promoting growth, developing infrastructure and managing the energy transition.

Their many contributions to the domestic economy and growth goals may have led some market participants and capital providers to expect a more systematic government support in times of financial tightness. The recent wave of defaults and restructuring of the past few years, while proving otherwise, is also providing long-needed insights on which sectors or companies governments will prioritize during stress. This brings back to the forefront the importance of stand-alone credit analysis even for state-owned companies.

Appendix

Table 4

Table 5

Editor: Jasper Moiseiwitsch

Digital designer: Halie Mustow

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