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China's state-owned companies encumbered by world's biggest corporate debt pile

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China's state-owned companies encumbered by world's biggest corporate debt pile

Many of China's state-owned companies are mired in heavy debt and may need external help as the economic slowdown limits their ability to grow earnings, according to a report by S&P Global Ratings.

Recent stress tests by Ratings showed that the bottom 90% of state-owned companies by revenue have had to borrow more to repay existing loans, according to a report published Sept. 20. The rating agency conducted stress tests for higher inflation and interest rate spreads on 6,363 Chinese companies, including 2,177 state-owned enterprises. Most of the companies in the study are not rated, though they account for more than half of China's total corporate debt.

Corporate debt in China reached nearly US$29 trillion in the first quarter, the highest in the world and roughly equivalent to the size of total U.S. government debt, Ratings said. The ongoing troubles at property developers and efforts by them to raise funds have hogged media space, but Ratings sees increasing warning signs emerging for a wider range of industries including construction, engineering, consumer discretionary and consumer staples.

"The slowdown in China's economy is making operations more challenging, and many [state-owned enterprises] and other corporates will find it hard to grow their way out of their heavy debt burdens," Terry Chan, senior research fellow at Ratings, said. Low earnings and heavy debts are common strains.

Dominant state sector

State-owned enterprises dominate China's economy, especially strategic national sectors such as energy, telecom and banking. In addition, regional and even city governments own companies that keep the economy humming. China's gross domestic product growth slowed to 0.4% year over year in the second quarter, compared with 7.9% in the same period the prior year. As the outlook for the economy remains clouded, the nation's central bank is expected to continue cutting rates even as most major global central banks shift their focus to inflation control.

Under Ratings' base-case scenario, 13% of Chinese companies will become cash flow-negative by 2023, compared to 9% in 2021. The figure triples to 28% under the rating agency's worst-case scenario, driven by high indebtedness and low earnings. The worst-affected state-owned companies account for 45% of China's nonfinancial corporate debt but generate just 15% of earnings, Ratings said.

A credit correction is underway in China, in which lenders and investors will curb further lending to less-creditworthy borrowers, Ratings said. In turn, that may lead to increased nonperforming loans for banks and more defaults, it added.

Ratings said it believes that the corporate sector can escape the debt trap, "but it will mean significant pain and perseverance."

The Chinese government, with much lower general government debt leverage than the U.S. and the eurozone, still has capacity to extend support to its state-owned companies, Ratings said. Possible steps include imposing gearing caps similar to the "three red lines" policy rolled out on property developers, it added.