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China State Enterprises Likely to Suffer More Defaults, S&P Says

  • Government appears willing to shut those in bad industries
  • Leverage at largest state firms has reached `critical level'

China’s state-owned enterprises are likely to suffer more defaults over the next year as the government shows its readiness to shut companies in industries struggling with overcapacity, according to Standard & Poor’s.

“In a major policy shift, the central government appears willing to close and liquidate struggling enterprises in the steel, mining, building materials, and shipbuilding industries,” S&P analyst Christopher Lee wrote in a report Monday. “We believe this stance will exacerbate the problems of companies in these cyclical and capital-intensive sectors, which are facing sluggish demand amid slowing investment growth.”

The warning follows S&P’s decision earlier this month to cut China’s sovereign rating outlook to negative from stable because economic rebalancing is likely to proceed more slowly than it had expected. Moody’s Investors Service also downgraded the outlook to negative in March, highlighting surging debt and the government’s ability to enact reforms. The revisions were biased, Finance Minister Lou Jiwei said in Washington on Friday.

Premier Li Keqiang has pledged to withdraw support from so-called zombie firms that have wasted financial resources and dragged on economic growth, which is at the slowest in a quarter century. China’s central bank has lowered benchmark interest rates six times since 2014, underpinning a jump in debt to 247 percent of gross domestic product.

China Railway Materials Co., a state-backed commodities trader, is seeking to reorganize debt and halted trading on 16.8 billion yuan ($2.6 billion) of bonds this month. Baoding Tianwei Group Co. last year became the first government-backed company to renege on onshore bonds. Sinosteel Corp. defaulted on onshore debt in October.

Leverage among the largest state-owned enterprises has reached a “critical” level, according to Lee. It is likely to worsen in 2016 as a weak top line is not fully offset by cost cuts and capital expenditure reductions, he wrote in the report.

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