WHEN banks lend to Chinese state-owned enterprises (SOEs), they price in the assumption that the government will rescue them if trouble strikes. How much is this assumption worth? Credit ratings help provide an answer. Ratings agencies grade SOEs according to two standards: a stand-alone rating (based on the companies’ finances) and a state-backed rating (factoring in government support).
This chart illustrates the extent to which SOEs benefit. The horizontal axis is their original rating. The vertical axis is their final rating after state support is added to the equation. The size of the bubble indicates the size of their debt. When ratings are unchanged, as is the case for most private companies, the bubbles incline upwards along a 45-degree angle. But when ratings are boosted, the bubbles migrate above the 45-degree line: virtually all SOEs are in this category.
The impact of the ratings uplift is big. In the Hong Kong bond market, average annual borrowing rates for SOEs should be 3.5%, based on their stand-alone profiles; that, however, falls to roughly 2% after state support is included. This amounts to a two-fifths discount on interest costs—quite the subsidy. But it will not last forever. As the economy slows and debt mounts, China is under pressure to let go of its worst-performing SOEs. Having propped them up for so long, though, it is tricky to withdraw support. Old habits default hard.
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