OREANDA-NEWS. Access to debt financing will further polarise among Chinese industrial corporates amid the government's capacity rationalisation reform, Fitch Ratings says. This could lead to an increase in credit events, including domestic bond defaults, from sectors suffering from over-capacity in 2016, but the state is likely to keep some large corporates afloat, especially state-owned enterprises (SOEs) with large workforces, and help them to reduce debt burdens via asset restructuring and recapitalisation.

We expect the overall domestic debt financing environment to be relatively benign for Chinese corporates in 2016. Minimising systemic risk and social unrest remains the top priority for the Chinese government as the economy further weakens. This policy tone was evident in a master document released by the Chinese government on 16 February 2016 to provide broad directives for domestic lending to industrial-sector corporates. In addition, the monthly net new loans extended to non-financial institution sectors (which include corporates and local government funding vehicles) reached a record high in January 2016.

The Chinese government advises banks to further differentiate their lending policies towards corporates in traditional industries. Banks are encouraged to support those still economically viable or have the potential to turn around but face temporary liquidity crunches, reflecting the government's intention to maintain stability.

In contrast, banks are advised to reduce or exit lending to "zombie corporates" that have racked up persistent losses and are clearly insolvent, suggesting a potential increase in default rates in 2016. The big challenge remains how to classify and define "zombie" corporates, particularly as local governments try to balance reducing overcapacity against maintaining social stability.

We believe the government still has incentive to keep many large SOEs afloat in light of their social impact. A default by a prominent SOE could trigger a tightening in external financing - albeit temporarily - for all corporates in the same region. As a result, we think these ailing SOEs are likely to survive through some form of asset reshuffling, including stripping off their non-performing operations along with some debt re-capitalisation.

Corporates in strategic emerging and modern manufacturing industries, including high-tech, high-end equipment manufacturing, new energy vehicles, will continue to enjoy favourable conditions for securing bank lending and capital market financing. Large SOEs undertaking strategic and pioneering roles in these sectors, in particular, will likely be the beneficiaries of the favourable environment.