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Reform benefitting giant SOEs may hurt smaller ones
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The credit quality of Chinese non-financial state-owned enterprises will diverge further as a result of economic and SOE reforms the central government is expected to enact over the next five to 10 years.
Reform will not materially affect the strategically important sectors. The state will continue to allocate resources, including capital and government-sponsored research, to strategically important sectors like energy and defense. This continued support will likely maintain the very strong credit quality of SOEs in those sectors.
The outlook is more challenging for SOEs in less strategically important and competitive sectors. We expect the state will gradually reduce its investment, support and involvement in these sectors as it is seen as less important that the state retains control over them. Examples of such industries include steel, building materials, light manufacturing, and property development.
Reducing its stake will allow the government to direct the sales proceeds and other state resources to strategically important industries. But leaders in these industries will continue to benefit from support.
Long-term investors will need to differentiate between SOEs most likely to remain in government ownership and those that will not. In particular, we expect the risk of being privatized will increase for subsidiaries of SOEs operating in less important sectors. These may not benefit from support to the same extent as their parents, and the parent SOEs may divest these subsidiaries over time or opt not to bail them out when they are in difficulty.
Slower economic growth and economic transition will be painful for SOEs in sectors with excess capacity. Government initiatives to reduce reliance on investment to drive economic growth will hurt SOEs in sectors that are suffering from overcapacity problems, such as steel and metal, building materials and construction.
Other reforms will have varying but generally mild effects. While the government is encouraging more private investments in the sectors dominated by SOEs, we expect that the progress will be slow because there are still high systematic barriers for private capital to participate.
In addition, large SOEs in formerly protected sectors, such as oil and gas, telecommunications and railway, have accumulated significant advantages in technology, experience, client relationships and distribution networks, which are difficult for potential competitors to replicate in a short period.
Reforms in financial sectors such as interest rate liberalization, more direct financing and relaxation of foreign-exchange controls generally benefit SOEs by increasing their funding channels.
However, we also expect some negative implications. For example, SOEs with large investments in financial segments are exposed to systematic risks from the development of China’s shadow banking system.
The writers are analysts with Moody’s Investors Service. The opinions are their own.
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