OREANDA-NEWS. Fitch Ratings says that large state-owned enterprises (SOEs) could start to be more tolerant of failures of their non-strategic subsidiaries and/or affiliates, as the Chinese government's financial reform plan progresses.

Defaults by non-strategic, commercially unviable SOEs can help to instil greater market discipline and reallocate capital more efficiently within the economy. The agency expects defaults by SOEs to become less uncommon in China's corporate bond market, but still sporadic and isolated, as controlling systemic risk remains a top priority for the Chinese government while the economy remains soft.

Baoding Tianwei Group Co. Ltd.'s (Tianwei) failure to meet a bond coupon payment due on 21 April indicates that SOEs are no longer shielded from credit events in China's onshore bond market. Baoding Tianwei is a Chinese electric equipment and solar manufacturer and is a wholly owned subsidiary of China South Industries Group Corporation, one of China's largest military defence companies and 100% owned by the State-owned Assets Supervision and Administration Commission (SASAC).

China's corporate bond market has not been immune to credit events and some degree of credit spread differentiation has already emerged since the occurrence of a few credit events over the last 12 to 18 months, including those from Shanghai Chaori Solar Energy Science and Technology Co. Ltd. and Cloud Live Technology Group Co Ltd. However, SOEs have still broadly benefited from a wide perception of implicit state support, which allows them to obtain lower cost debt funding than privately owned companies.

Although Tianwei's post-default plan remains unclear (and some form of bail-out could still be a possibility), Fitch believes that a default from a relatively small, non-listed state-owned entity, which is only indirectly held by the SASAC and operates in a fully market-driven sector with little synergy and low strategic importance to its larger and stronger SOE parent, fits the Chinese government's intention to allow isolated cases of financial risk and give market forces more say in the economy. In fact, Fitch expects large SOEs to start stripping off non-core, less strategic assets, particularly those operating in sectors suffering from structural downturns and capacity surpluses.

Fitch expects that more SOEs could be allowed to default, to instil credit discipline and facilitate capital reallocation in order to serve the government's reform agenda. However, state authorities could still intervene in varying forms on a selective basis, as they gauge the impact of each default case on the debt capital market and the broader economy, particularly if there is a bigger chance of heightened market volatility that potentially hampers the access to liquidity and funding by corporates, which are to be promoted and supported during the reform. The government is likely to maintain a cautious stance on defaults of large monetary values, those that involve large corporates in strategic sectors, and/or those that hurt a large number of retail investors in the near term.