What If S&P Downgraded China?

Most of the recent negative rating actions in China have been focused on the deterioration of standalone corporate fundamentals. However, given the macro challenges, the number of Central SOEs (state-owned enterprises) in China investment grade and sovereign linkage – a change in China's sovereign rating/outlook could have rating and re-pricing implications for the broader universe.

A sovereign credit rating is the credit rating of a sovereign entity, i.e., a national government (in this case, China). The sovereign credit rating indicates the risk level of the investing environment of a country and is used by investors looking to invest abroad.

"We would stress that a China sovereign downgrade is certainly not our base case (at least not within the next 6-9 months) but we suspect the market will at some point start to focus on this in the absence of a meaningful recovery/stabilization in China macro," Deutsche Bank analyst Colin Tan said in a note.

Related Link: How Yuan Policy Affects China ETFs

Tan assessed the impact on the issuer's final rating if S&P downgrades China's sovereign rating by a notch to A+, assuming there are no changes to either the stand-alone credit profile (SACP) or the strength of government support.

The analyst also assessed the impact on final rating if SACP were to come down a notch (again by holding all other variables constant).

A one-notch sovereign downgrade would likely result in a one-notch cut for the following 11 issuers:

• China Merchants Holdings (Intl)
• China National Petroleum Corp
• China Petrochemical Corp
• China Petroleum & Chemical Corp
• China Railway Construction Corp
• China Shenhua Energy
• CNOOC Ltd (ADR) CEO
• Kunlun Energy
• Power Construction Corp of China
• State Grid Corp of China
• State Grid International Development

The analyst said the following 15 companies issuers would likely be affected if their SACP were cut by a notch:

• AVIC International Holding Corp
• Baosteel Group
• Baoshan Iron & Steel Co Ltd
• Chalco
• China General Nuclear Power Corp
• China Merchants Holdings (Intl)
• China Oilfield Services Ltd
• China Overseas Grand Oceans Group
• China Railway Construction Corp
• China Railway Group
• China Resources Gas Group
• China Resources Land
• China State Construction Engineering Corp
• Kunlun Energy
• Power Construction Corp of China

The analyst noted that Sinopec Shanghai Petrochemical Co. (ADR) SHI and CNOOC have the biggest buffer to withstand deterioration in standalone credit fundamentals (i.e., six notches SACP cut before a final rating downgrade).

Currently, Standard & Poor's credit rating for China stands at AA-. Moody's at Aa3 and Fitch's credit rating is A+.