Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

So what if there's a lot of China debt out there, and the pile just keeps getting bigger? Investors, at least, appear not to care.

As President Xi Jinping prepares for a second five-year term, he's already managed to convince markets that China's deleveraging train has left the station -- never mind that there's no evidence state-owned enterprises have even begun to shed assets or debt, more than a year after the government rolled out steps to rein in borrowing.

At the end of 2012, just before Xi took office, as many as 986 nonfinancial state-owned and state-linked enterprises had a little more than $2 trillion in assets supported by around $775 billion in shareholders' funds, an analysis by Gadfly shows. Assets have since swelled to $3.6 trillion, while the equity cushion has grown to only $1.25 trillion.

Financial leverage -- assets divided by equity -- has thus risen to 286 percent, from less than 274 percent, on the eve of this week's twice-a-decade Communist Party congress. The saving grace is that the ratio appears to have stabilized, albeit at an elevated level.

What Deleveraging?
State-owned and linked companies in China are financially stretched, with total assets of almost $3.6 trillion but only $1.25 trillion in equity*
Source: Bloomberg
*Based on a sample of 986 publicly traded non-financial firms.

For leverage to come down to a more reasonable plane, SOEs needed to feel some tightness from the efforts of outgoing central bank Governor Zhou Xiaochuan this year to engineer an onshore liquidity squeeze. That's been undermined by a recovery in producer prices, which has boosted cash flows. While state firms' return on assets is more than 1 percentage point lower than in 2012, profitability is on the mend. 

Sweating Assets Better
Profitability of China's state-owned and state-linked firms has stopped falling
Source: Bloomberg
*For a sample of 986 publicly traded non-financial firms.

That removes the urgency to deleverage. Bloomberg's Default-Risk Model, which uses transparent market inputs such as share prices, debt outstanding and interest expenses to calculate the probability of companies reneging on their obligations in the year ahead, shows far more upgrades this year than downgrades.

Finding Their Feet
More state-owned firms have seen their creditworthiness improve from a year ago than have seen a deterioration, according to a Bloomberg default risk gauge*
Source: Bloomberg
*Based on a sample of 931 publicly traded firms.

The International Monetary Fund warned in August that ending Chinese state companies' addiction to debt would require more work, including sweeping shifts in the way capital is allocated. Instead of reforming SOEs, China's mantra has been to merge them into ever-bigger giants, or inject small amounts of private capital while keeping the behemoths firmly in state hands. S&P Global Ratings and Moody's Investors Service both downgraded China's sovereign rating this year over the continuing buildup of debt.

Yet money keeps flowing into Chinese stocks and bonds. A $2 billion sovereign note, China's first dollar issuance since 2004, is all but sold as yield-hungry investors pile in for a chance to buy a piece of the world's second-largest economy. Postal Savings Bank of China Co., which listed in Hong Kong last year, raised $7.25 billion from a sale of perpetual preference shares in September with a coupon of just 4.5 percent.  By contrast, a higher-rated $1.25 billion perpetual from Canadian lender Bank of Nova Scotia had to shell out 4.65 percent this month.

Whether money will remain abundant for China's SOEs will depend on Xi's ability to keep the market convinced of his determination to see through the deleveraging campaign.

For now, he's winning the battle of perception. Whether he can continue to do so during his second term, as central banks start removing excess liquidity from the global financial system, is another matter. 

--With assistance from Shuli Ren.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Nisha Gopalan in Hong Kong at
Andy Mukherjee in Hong Kong at