The number of companies in China at risk of default is poised to rise over the medium term as slower domestic GDP growth and the central government's reform agenda, which aims for greater progress toward a market economy, expose overstretched balance sheets in the corporate sector.

In this environment, high-yield private companies in sectors with excess capacity, such as steel, mining, solar, commodity trading and shipbuilding, are most likely to exhibit signs of distress because their financial profiles are relatively weak and their access to funding is limited.

Corporate credit metrics－such as liquidity and leverage－have been weakening for some time, particularly in the high-yield segment, meaning that further defaults cannot be ruled out.

Corporate revenues have fallen in lockstep with the slowdown in GDP. During the first quarter, revenues for companies listed on the A-share market contracted by 4.2 percent year-on-year. Weaker revenues have increased systemwide corporate leverage, which stood at 150 percent of nominal GDP in the third quarter, according to Moody's estimates, a 34-percentage-point rise over the past five years

However, continued policy easing and government support will prevent an escalation of corporate defaults and systemic risk to the onshore and offshore markets. Accordingly, corporate defaults in China, while increasing in frequency, are likely to remain largely isolated events.

One of the most obvious examples of the effects of this approach is the high-profile property sector, where market conditions stabilized during the January-April period, raising expectations of a modest recovery in sales volumes for 2015, a sharp contrast to the decline evident in 2014.

The central government has adequate fiscal and monetary headroom and exerts sufficient control over the economy to avoid widespread corporate failure and support the banking system. The authorities are also demonstrating a renewed bias toward policy easing and flexibility toward structural reform to engineer a soft landing.

Room is available for a further loosening of monetary policy should macroeconomic conditions continue to deteriorate, given that real lending rates and the reserve requirement ratio remain high by historical standards.

Recent actions by the central government in regard to local governments indicate that it has the ability and willingness to act swiftly in adjusting domestic funding conditions should macroeconomic or market conditions justify such a move.

Specifically, in May, it issued a directive instructing banks to continue lending to local government financing vehicles for projects approved as of September 21, and it also announced that these governments' bonds now qualify as collateral for borrowing from the central bank.

Both of these measures should ensure adequate financing for local governments, thus helping stabilize local economic activity and in turn helping out local corporates.