Debt has been rising for China's local governments as well as for many of the state-owned entities (SOEs) they control. These double burdens have changed the dynamics for the likelihood of SOEs receiving extraordinary government support. S&P Global Ratings expects a gradual shift toward more differentiation will continue, with the smaller and uncompetitive commercially driven SOEs likely to see diminishing support over time.

China has more than 300,000 SOEs and in recent years, a small number of SOEs have defaulted on its various financing products. We view this as an indication that local governments are becoming more differentiated in providing extraordinary support to local SOEs.

At the same time, key SOEs that have important policy or social roles, or are industrial champions, are unlikely to see material weakening of government support. In some cases, some may see government support strengthening, because they have taken on new mandates, policy roles and their importance has grown--such as the newly designated state capital investment and operation companies.

Our report examines some 50 rated corporates and financial institutions owned by China's local governments ("local SOEs"). These entities are among the biggest and most important to their respective local government owners. They are unlikely to experience a rapid change in support levels. Nonetheless, the rated sector is not completely immune from the differentiation trend (see "China's Local Governments: Capacity To Support SOEs Will Be Tighter For Longer," published on RatingsDirect on July 8, 2024).

Rising debt burdens mean local governments may have to make some harder choices. We identify and analyze key factors that could diminish support levels and address key investor questions.

Frequently Asked Questions

What factors may indicate a risk of eroding support for SOEs?

In our view, the SOEs most vulnerable to weakening government support are:

• Owned by local governments that have a weakening capacity to provide timely and full financial support.
• In sectors or transitioning into sectors that are less important to local governments, e.g. with respect to their public functions, strategic development, financial stability; or whose functions can be more easily undertaken by another entity.
• Commercially driven SOEs with deteriorating business fundamentals and limited prospects of self-sustaining operating performance.
• Entities that have been restructured or consolidated, resulting in weaker linkages to local governments, such as lower ownership or diluted control.

We have lowered our assessment on the level of support for three local SOEs in the past few years (see table 1). It is worth noting that despite these adjustments, we expect these companies continue to benefit from extremely high likelihood of receiving extraordinary government support as shown in the table:

Table 1

Following some high-profile distress incidents in the years leading to 2020, local governments have, in our view developed more tools to oversee SOE debt and liquidity risks. Many local governments developed electronic systems for real-time monitoring of SOE debt and liquidity situations and increased frequency of reporting. Some local governments set up local relief funds (a.k.a. "rescue funds") to provide emergency liquidity and/or capital injection to selected SOEs.

Their increased preparedness on debt management and procedures for support has made a significant difference. For example, there have been fewer public bond defaults of local SOEs since Yongcheng Coal and Electricity Holding Group (Yongmei), owned by Henan provincial government, defaulted in 2020 (see "China Default Review 2024: Trough Before The Third Wave," April 23, 2024).

Are SOEs owned by stronger local governments therefore less likely to see support levels eroding?

Not exactly. It's true that stronger local governments tend to offer more ongoing support and have more resources to manage SOE debt risks. Capital or asset injections, buying of assets, government subsidies, and facilitating bank lending are common forms of ongoing support to SOEs in challenging sectors or downcycles. Ongoing support can also be preemptive, such that SOE financial positions are preserved for debt repayment.

Nonetheless, in our view, an SOE's link and role to local governments is the key determinant for extraordinary support (see "Rating Government-Related Entities: Methodology And Assumptions," March 25, 2015). Ongoing support could be an indication of the commitment of support from the local government, but not the sole driver of our assessment on extraordinary support in distress situations. Some key SOEs serving important functions in weaker regions would also receive strong support from their local governments.

Chart 1

Among local SOEs rated by S&P Global Ratings, how do they stack up in terms of their likelihood of receiving extraordinary support from local governments?

The rated state asset investment and operating platforms, utilities and transportation infrastructure companies in our cohort tend to have higher likelihood of support assessment. This is because they tend to either perform crucial industry policy roles on behalf of governments, or provide essential public services, hence their stress could cause a much wider contagion among local SOEs.

SOEs in commercially oriented and highly-competitive sectors, such as commodities, property development, leisure, brokerage, etc., are less likely to get a high level of government support if in trouble.

While many of our rated SOE banks and securities companies have strong linkage with local governments, many of them are not among the most important SOEs to the local government. This is partly because local banks tend to have higher replaceability and lower government ownership. Individual local banks are much smaller in scale compared with China's major commercial banks that are owned at the central level and dominate lending in almost all regions. And relatively speaking, securities companies' role in the financial market is less prominent than banks in China.

Chart 2

How do the individual credit profiles of SOEs affect their likelihood of receiving support from local governments?

For commercially-driven SOEs, local government support would likely prioritize better performing ones in temporary difficulties, rather than ones whose businesses fundamentals or capital structure aren't sustainable without support.

Several of the companies in our cohort have low stand-alone credit profiles (SACPs) in the single 'b' category. The median fall into the higher 'bb' categories, though nearly 20% of the cohort have investment-grade SACPs and these ones would be less likely to get into a distressed situation. That said, the likelihood of support from government for these entities could weaken if their credit profiles are persistently deteriorating.

For policy-driven SOEs, their financial performance is a less relevant factor. Their policy roles and the essential services that they provide play a key part in our assessment of local governments' likelihood of support.

Chart 3

Will commercialization lead to the erosion of support?

It depends. This is the key issue for support across China's broader state-owned sector, but particularly for local government financing vehicles (LGFVs). China's central government has mandated that LGFVs become more self-sufficient, including on the repayment of their debt and other financial obligations. However, this doesn't automatically mean government support for these LGFVs will weaken (see "China Brief: LGFVs Face Credit Differentiation As Transition Deadline Looms," Oct. 17, 2024).

We believe the process will be challenging for most LGFVs. They will attempt to make the transition by moving into areas such as industrial parks development, commodities, utilities, industrial investment platform, and financial services.

In our view, there is no proven template for an SOE to become more commercially driven. There are some examples of transitions by way of mergers with other SOEs to create a bigger entity to strengthen their market competitiveness and improve their capital structure. The key to the transition is whether the SOE can improve and sustain its financial position as a going concern. The current tepid economic cycle is also hindering this process.

A widely circulated (though not public) policy document, known as "Decree 150," calls for a more concrete timeline on LGFVs' transformation into "regular SOEs," meaning more self-sufficient and commercially operated.

The commercial exploration of LGFVs does not necessarily diminish the significance of the functions they serve for the government. They may continue to invest and operate in areas directed by the government, but they will exercise greater commercial discretion regarding projects on a case-by-case basis. An example of this is social housing.

We expect the level of support to gradually erode for some LGFVs rather than quickly for all. Whether and how this occurs for a LGFV will depend on the entity's business fundamentals, the continual importance of its function to the government (see table 2 in Appendix), and the resources available from the local government. Any erosion will be assessed on a case by case basis.

Does higher profit mean a lower likelihood of support for local SOEs?

No, not necessary. Some of these profitable enterprises are also industry champions. Their role and importance to the local government is a more important factor than how profitable they are in our assessment of extraordinary government support.

There are plenty of examples of commercially driven SOEs that we have assessed to benefit from strong extraordinary support--such as Beijing Automotive Group, Shanghai Electric Holdings Group, the two local SOEs are expected to have very high likelihood of extraordinary support from respective local municipal governments. The two companies play a very important role for local governments due to their solid market position in auto industry and capital goods industry, the sectors that the government targeted to develop.

Does S&P Global Ratings expect subsidiaries of local SOEs to benefit from extraordinary support from government?

Yes, for most rated issuers. Our assessment is based on various factors aside from the alignment of its role and strategy, including track record, such as parent guarantees on subsidiary's bonds; cross-default clauses in the parent's bond documents; emergency funding arrangements; and shared bank loan facilities, or bank loan facilities given under parents' influence.

Government support can be extended to the subsidiaries via the parent, in cases where the subsidiary performs a key role within the group that aligns with the group's role for government. For example, despite Haitong International Securities Group Ltd.'s (HTI)'s substantial losses in 2023, HTI remains Haitong Securities Co. Ltd.'s overseas flagship. Haitong delisted HTI and extended financial and operational support to the Hong Kong based subsidiary. Haitong's strong link with the Shanghai government provides buffers against further losses and indirectly benefits HTI. (see "Haitong Securities Has Capital Buffers Against Legacy Risks; 'BBB' Rating Affirmed With Negative Outlook," July 30, 2024)

Consistent or strengthening ongoing support is also a gauge of a subsidiary's importance to the group. There are exceptions where subsidiaries' business or geographical focus diverge significantly from their parents' hence we don't anticipate government support to the parent would flow through to these particular subsidiaries.

Appendix

Table 2

Table 3

Table 4

Related Research

• China's Upper-Tier Local Governments Are Not Immune From Debt Buildup At Lower-Tiers, Jan. 16, 2025
• China's Local Governments: Downside Risk Is Rising For Fiscal Consolidation, Dec. 17, 2024
• China's RMB10 Trillion Debt-Swap Scheme Is A Good Start, Nov. 13, 2024.
• China Brief: LGFVs Face Credit Differentiation As Transition Deadline Looms, Oct. 17, 2024
• Haitong Securities Has Capital Buffers Against Legacy Risks; 'BBB' Rating Affirmed With Negative Outlook, July 30, 2024
• China's Local Governments: Capacity To Support SOEs Will Be Tighter For Longer, July 8, 2024
• China Default Review 2024: Trough Before The Third Wave, April 23, 2024
• SLIDES: China City Governments Risk Falling Into A Debt Trap, Feb. 20, 2024
• China Plays It Safe In Handling Troubled Bank Of Jinzhou, July 30, 2019

Criteria

• Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015