Standard & Poor's Ratings Services says China's overall industrial sector remains on a path of solid growth, despite restrictive government policies.

The opinion was proffered in a new report entitled "China Top 100 Corporates: the Changing Shape of China's Economy".

However, the ratings agency also identified four areas of significant uncertainty that need to be closely monitored - margin contraction, mounting risk of overcapacity, consolidation, and expansion abroad.

"China remains a classic emerging market, with all the hidden dangers and opportunities," said Standard & Poor's credit analyst John Bailey, head of Standard & Poor's Greater China corporate ratings group.

"The economy is growing at breakneck speed, with investment still increasing at a healthy pace, but not everyone is keeping up," he added.

Overcapacity and higher costs, fuelled by continued economic bottlenecks, are causing margin squeezes for many intermediate and downstream industrial enterprises. As a result, some companies' profits have been hit.

The combined earnings of China's top 100 corporations rose 39 per cent in 2004, compared with 85 per cent in 2003. However, if producers of raw materials such as steel, minerals, petroleum, and petrochemicals are excluded, earnings rose by a significantly lower 25 per cent.

This apparent erosion of earnings growth in some parts of the industrial sector is likely to spur consolidation as companies try to increase scale and improve efficiency.

Consolidation is most likely among automakers, property developers, low-end steel producers and mobile-phone producers.

Foreign expansion by major Chinese corporations is another source of uncertainty. Capital expenditure levels are expected to grow strongly for some of the larger companies as they seek to restructure and expand their business. This could entail foreign investments, as well as mergers or acquisitions. Such activities create significant operating risks that could compound financial risk brought through higher debt leverage. Chinese companies are already beginning to make outward investments, such as Lenovo Group Ltd's acquisition of IBM's PC business and investments by state-owned oil companies in offshore energy projects.

A further issue that needs to be closely monitored is the revaluation of the renminbi.

The government's recent revision of its exchange rate is not expected to have a major impact on the corporate sector.

The main beneficiaries of a stronger renminbi are likely to be airlines, as a result of significant translation gains from their foreign currency debt exposure, and refineries, which should benefit from lower costs for imported raw materials.

Conversely, a stronger renminbi is likely to increase pressure on the margins of export-orientated companies, especially those lacking the competitive strength or pricing power to pass costs on to customers.

"It will be extremely interesting over the next decade to see which companies emerge from the current list of leading players in China as winners," Bailey said.