China is changing. Economic priorities are shifting, industries are consolidating, and as headline growth slows, companies are increasingly focusing on efficiency and margin. The major state-owned enterprises (SOEs) are affected by these trends and, in many cases, leading them. What are the credit implications?

This report focuses on corporate SOEs owned by the central State-Owned Assets Supervision and Administration Commission (SASAC) and centrally-owned financial institutions ("central SOEs"). These entities comprise some of the biggest companies in China, and the world. That includes major banks, steelmakers, power companies and telecom operators, among others.

S&P Global Ratings believes the central government has the will, and the resources, to support these key entities. Nonetheless, the level of support varies, and overall, we see the possibility that support for some sectors could wane over time.

The central SOEs have generally played key roles in ushering in China's economic transformation in recent decades. Yet over time, some of these companies will likely be absorbed, others will be created or see their roles transformed by "new economy" priorities. In this report, we address key questions regarding this transition.

Frequently Asked Question

Has the Chinese government's support for central SOEs weakened over the past several years?

Not in our view. We believe support has remained largely stable, even amid pandemic-related hits to the economy and credit markets. No central SOEs controlled by the SASAC has defaulted since 2017. Preventing reputation risk for central SOEs continues to be a critical goal for SASAC.

We think the central government's capability to support SOEs directly under its control remains solid. This is because the government commands vast resources to mitigate default risks; this includes the strong financial resources available to it from its holdings.

For example the central government has transferred more companies to SASAC, such as China Rong Tong Asset Management Group Corp. and China Anneng Construction Group. Both entities were previously owned and managed by the armed forces. The additional assets further boosted SASAC's capability to facilitate resource allocation among central SOEs.

In our opinion, the state capital investment and operating platforms can reallocate resources to support SOEs and prevent SOEs going into default. This is credit positive.

As China's growth engine transitions from old economy to new economy, how will this affect support for central SOEs?

We do not expect support for SOEs to wane during the transition. The central government has repeatedly emphasized the importance of stability. We expect the central SOEs to play a stabilizing role in the old economy and a leading role in the new economy.

In our view, China will focus on consolidating and reducing overlap for industries that are stagnating or even shrinking as the country's growth model evolves. Companies that experience stress would more likely be absorbed by another SOE than allowed to go bankrupt. A larger combined entity has more resources to manage financial stress, remove duplicate output, and improve margin and efficiency over time.

Since 2015, we have seen 23 mergers and operation custodies among SASAC's regulated central SOEs— particularly over 2015-2018 for heavy industries. For most of these mergers, our assessment of likely extraordinary government support remained unchanged. In our opinion, SASAC's intervention signaled that the administration was aiming to improve competitiveness to prevent financial risk from materializing.

What sectors could see their importance to the central government decline?

Heavy industrials will play a lesser role in the economy, over time, as China switches away from investment and exports to innovative technology, energy transition, and artificial intelligence. Consolidation can improve capital efficiency as growth decelerates. This path has already been taken in some sectors--steel, aluminum, cement--to reduce duplication in resources.

Some heavy industries are showing signs of slowing but are not yet under pressure to consolidate. In time, such strains will grow, however, for these sectors, which include engineering and construction, conventional auto/auto supplier, and capital goods (machinery and heavy equipment).

The consolidation will be policy-driven and typically the catalyst is a crisis. Most central SOEs command vast resources and mergers would reallocate the command of the resources to the surviving entity. Management streamlining is another disincentive.

Does the national strategic importance of various sectors affect the likeliness of central-government providing extraordinary support?

Yes. While our assessment of the likeliness of support is entity specific, and based on a host of factors, the relative importance of the sector to national and economic interests is a key determinant (see chart 1).

Chart 1

• In general, entities operating in national defense, aeronautical as well policy institutions rank ahead of other entities. We rate three policy banks equal to the sovereign rating on China: China Development Bank, China EXIM Bank, and China Agricultural Development Bank.-.
• On the other end of the spectrum, entities operating in competitive sectors with fewer policy mandates--such as those in real estate and consumer goods--would, in our view, receive the lowest level of extraordinary government support.
• In between the two extremes, various sectors and industries occupy the full range of the spectrum. In general, rated banks have higher support vs corporates as well as nonbank finance companies.

Some SOES owned by local governments have exhibited distress in recent years. How, in general, does the credit quality of corporate central SOEs compare with local-government counterparts?

It's stronger. The median stand-alone credit profile of our rated central SOEs is 'bbb' versus 'bb 'for our rated local SOEs.

Chart 2

Central SOEs generally operate across the entire country and thus benefit from larger scales than those of local SOES. The central-owned entities also often have dominant market positions and preferential access to capital and bank credit.

In some industries, central SOEs are the key service providers in strategic sectors for the Chinese economy: fixed-line telecommunications, mobile communications, oil and gas, power generation, power grid, steel, and nonferrous metals. Other entities are either the sole, or one of two providers, in national defense--aerospace, aeronautical, shipbuilding, and military equipment.

The credit quality of the central government is also a strength for the central SOEs. The capacity to support and the resources available to the central government is vast compared with local governments.

Deleveraging and other SASAC-guided reform efforts over the years have bolstered the financial positions of many central SOEs. Since 2020, the average ratio of liabilities to assets of SASAC-regulated central SOEs has hovered around 65%. This is a target of central SASAC, and also an acceptable leverage ratio for lenders--a ratio below 70% would generally suggest a relatively healthy balance sheet in some lenders' view. SOEs' assets are stated at cost and thus often understated, providing a degree of buffer to asset value fluctuations.

Chart 3

What are the "state capital investment and operating platforms" and do entities designated as such have a higher likeliness of receiving government support.

No, we do not ascribe stronger support specifically to state capital investment and operating companies. Support is entity specific, and we consider a number of factors when evaluating the link and importance of the entity to their reference government.

China's central SASAC created these platforms as part of a pilot initiative to improve the allocation and efficiency of state capital. Most are state capital investment companies, and only two are operating platforms (see table 2, in Appendix, for list of companies). These companies are in some of the key sectors for the Chinese economy such as energy, power generation, steel, aluminum, and shipping.

We recently raised our assessment on the likeliness of support by one category for three state capital investment platforms. Their status as special platforms, however, was not the sole reason for this move. Rather, it reflected their expanded roles in restructuring other SOEs and improving state asset efficiency. Two are diversified conglomerates and one is in the power generation sector.

Will government support change for the "big four" distressed-asset management companies (AMCs), given their weak financial performance.

We expect government support for these national AMCs will remain very high. The big four are an integral part of China's financial stability framework, given their core role in helping the government to resolve risks in the financial system.

Heightened credit risk in the current economic cycle calls for greater AMC involvement. In addition to the core "bad bank" function (i.e., acquiring and disposing nonperforming assets from financial institutions), AMCs have been guided to strengthen their support to distressed entities, including small and midsized troubled financial institutions, indebted local governments or their funding platforms, and ailing property developers.

Continued large impairment losses from significant property exposure has narrowed capitalization headroom against the regulatory requirement for some AMCs. This in turn will also constrain their ability to acquire stressed assets. However, regulators have taken a number of steps to bolster the AMCs' capitalization and liquidity and help them execute their policy roles:

• In January 2023, the People's Bank of China set up special refinancing loans for national AMCs at up to Chinese renminbi (RMB) 80 billion with a below-market interest rate of 1.75%. The loans supported their participation in restructuring and accelerating risk resolution in the property sector.
• In June 2022, regulators provided extra incentives to commercial banks, insurance companies and other financial institutions to subscribe to AMCs' financial bonds by reducing the required risk weight applied on these instruments.
• In August 2020, the regulator put one more tool, onshore perpetual bonds, into AMCs' capital-management toolbox to help them manage their capital issuance.

Are there examples of how the government provided timely and full financial support to AMCs in time of stress?

Yes. This was tested in the case of China Citic Financial AMC (formerly China Huarong AMC).

When the company suffered a RMB106 billion loss in 2020, it received a RMB42 billion capital injection from a group of strategic investors led by Citic Group, a conglomerate effectively wholly owned by the Ministry of Finance.

Last year, China Citic Financial AMC recognized unrealized gains from a couple of equity investments. This helped the company to turn a half-year loss into a full-year profit in 2023 and boosted the company's regulatory capital ratio well beyond the minimum requirement of 12.5%. These are apparently one-off profitable transactions, and in our view, reflect efforts by shareholders and the government to restore the company's capital strength.

Appendix

Table1

Table 2

Related Research

• China's Distressed AMCs: Government Support Will Be There, Feb. 2, 2024
• China GRE Ratings List, Nov. 28, 2023