The SOE Premium and Government Support in China's Credit Market

Abstract

We study how perceived government support for state-owned enterprises (SOEs), can shut out non-SOEs in China’s credit market, causing severe segmentation in credit pricing. Since 2018Q2, amid government-led credit tightening, the SOE premium – the difference in credit spreads between non-SOE and SOE issuers of the same rating, exploded from a stable level of 20 bps to well over 100 bps. Using issuer-level information on government equity ownership, we find that this sharp increase in SOE premium was driven by the increased importance of government support in credit pricing above and beyond the SOE label. Examining the real impact of this deepening allocational inefficiency, we find that, since 2018Q2, non-SOEs in China have lost their advantage in profitability and fundamental strength over SOEs. This segmentation also drives price discovery in two dimensions – non-SOE bonds became significantly more informative of credit quality, while SOE bonds became sensitive to government support. Overall, our results find a market of improved price efficiency, and, paradoxically, worsening segmentation as government support emerges as an important factor in credit pricing.