May 10, 2016 / 8:31 AM / a year ago

Ballooning state firm debt poses contingent risk to China - Moody's

* China SOE debt has risen to 115 pct of GDP

* SOE debt is higher in China than in any other nation

* Rising SOE debt could trigger state support

* Bringing SOE debt down could cost China 25 pct of GDP

* SOE risks could spill into banking sector

By Umesh Desai

HONG KONG, May 10 (Reuters) - Debt owed by China's state-owned enterprises (SOE) is higher than in any other rated nation and failure to curb risks from these liabilities would curb growth, lower credit availability and ultimately lead to state support, Moody's said on Tuesday.

In a report, the credit rating agencies said SOE liabilities stood at 115 percent of gross domestic product (GDP), far exceeding levels seen in countries such as Japan and South Korea where the state sector also plays a significant role.

China's SOE debt to GDP has risen from 100 percent in 2012 and represents the lion's share of China's total debt to GDP of 280 percent.

In Japan, SOE debt stands at 31 percent of GDP and in South Korea the ratio is 28.9 percent.

"Large and rising SOE liabilities - at a time when profitability is falling - could strain bank balance sheets, potentially necessitating support from the government," the agency said in a report.

Bringing down the leverage of the most indebted listed SOEs would require an equity injection of 2.7 trillion yuan ($414.4 billion), Moody's estimated in the report. Including the non-listed SOEs, the required capital injection was equivalent to 20 percent to 25 percent of GDP, it said.

Mergers in the sector were also to be expected, the agency said.

Moody's added that a planned debt-for-equity swap programme aimed at helping reduce the debt overhang in the sector could actually transfer risk from the corporate sector to the banking sector and would not be able to prevent a full-blown financial crisis.

"The swaps would not address issues of economy-wide financial stress and falling returns on assets," said Moody's, which lowered in March the outlook on China's Aa3 rating to negative from stable blaming uncertainty around reforms, rising debt and falling reserves.

Reforms to the SOE sector are critical to checking the rise in contingent liabilities, Moody's said.

Rising leverage and shrinking profit in the SOE sector would lead to a further rise in non-performing loans, which, if substantial and protracted, could also require equity injections for the banks, it said.

$1 = 6.5161 Chinese yuan Reporting by Umesh Desai; Editing by Lisa Jucca and Jacqueline Wong

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