Contingent liabilities of China’s state enterprises viewed as threat

Asia’s market participants regard hefty contingent liabilities – stemming largely from China’s state-owned enterprise (SOE) sector – as the main source of risk facing the Chinese authorities, reports Moody’s Investors Service.

The credit ratings agency’s (CRA) recent poll of market participants in Beijing, Shanghai, Hong Kong and Singapore also indicates they are split over whether or not China will face a financial crisis over the coming years.

Moody’s canvassed opinion from nearly 550 individuals in the four cities, including the region’s largest onshore and offshore investors, intermediaries, issuers and regulators – all with a focus on the credit risks facing China’s mainland.

Moody’s acknowledges that the high debt load of Chinese entities connected with the government raises contingent liability risk for the sovereign, further noting that the liabilities of China’s SOEs are significantly higher than for those any other rated sovereign.

At the same time, the CRA believes that an imminent financial crisis in China is unlikely, although “this will come at the expense of credit quality.”

Its conclusions are in a just-released report on the results of polls taken of market participants from late May through to mid-June in the four locations, who all attended Moody’s Mid-Year China Conference: Understanding the Risks of High and Rising Leverage.

The sustainability of a rising debt burden is arguably the key credit issue for China, particularly as it undergoes a structural shift towards services-orientated and consumption-led growth, the report says.

On average, 43% of those polled saw the crystallisation of contingent liabilities as the most pressing risk facing China’s government over the next two to three years, followed by weaker growth (27%) and a loss of reform momentum (14%).

Furthermore, there was broad agreement that SOEs represented the greatest source of contingent liabilities (72% of those polled on average). Respondents pointed to the use of a combination of measures – such as equity injections and bank debt rollovers – to resolve contingent liabilities.

A stabilisation in SOE leverage is unlikely anytime soon, according to the poll findings, with 53% of those surveyed expecting the debt-to-earnings before interest, tax, depreciation and amortisation (EBITDA) ratios of SOEs to rise slightly in the next 12 months, and almost 24% anticipating a significant increase.

Additionally, the banks are considered the most exposed to losses from ongoing capacity reductions at SOEs (37% on average), followed by corporates (28%), and regional and local governments (18%).

Despite broad-based concerns over rising leverage and the crystallisation of contingent liabilities, poll respondents were more evenly split on whether or not China will experience a financial crisis. Across all four locations, on average 41% of those surveyed don’t expect a financial crisis in China.

Against this, 15% of those polled expect a financial crisis to take place by mid-2018, 27% looking at a three-to-five year horizon, and a further 15% anticipating a crisis in five years or more. Only 3% expect a crisis to materialise in the next 12 months.

Market participants pointed to several important factors mitigating systemic risks, including the state-backed financial system (31%), the authorities’ monetary and fiscal space (28%), capital controls (24%), and the domestically funded nature of China’s credit boom (18%).


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