China: state owned enterprise reform
Published 7 August 2014
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Detail
China’s Third Plenum last November set the agenda for a new round of State Owned Enterprise (SOE) reform designed to increase efficiency and encourage more private investment. Local governments have moved more quickly than the centre to implement this reform. Expect reform of the huge, central SOEs to be a slow and controversial process.
Direction set by the Third Plenum
SOE reform was, unexpectedly, one of the main themes at the Third Plenum last November. The Decision document, which captures the outcomes of this meeting, not only paves the way for a series of factor-price reforms, reducing the subsidies that SOEs have enjoyed, but also committed to developing a ‘mixed-ownership economy’ and to establishing new State Capital Operating and Investment companies, modelled loosely on the approach taken in Singapore.
The idea of ‘mixed ownership’ was popularised in the last major push on SOE reform in the 1990s, when many central SOEs listed a minority of their shares on stock-exchanges to attract private capital. What’s new about this round of reforms is the focus on changing the governance structure of SOES,, encouraging private investors to take a controlling interest, and allowing employees to hold shares.
What’s motivating reform?
SOE reform has stagnated over the past 10 years; and SOEs are increasingly inefficient and unprofitable. In the first half of 2014, one third of central SOEs and half of local SOEs experienced declining profits or losses. HSBC calculates SOEs’ average debt-to-asset ratio is about 65 percent, above the 40 -60 percent range acceptable by private investors.
Yet, while private companies are responsible for nearly all new job creation, SOEs still dominate China’s economy. According to Credit Suisse, the total assets of non-financial SOEs represented 160% of Chinese GDP as the end of 2013. SOE monopolies in many fields shut out smaller market entities.
And as individuals and private companies rapidly accumulate wealth, China needs to provide more opportunities for investment. For example, Alibaba, a private company which provides China’s largest online shopping services, nearly tripled in size over 2014 Q1 and is now looking to invest in multiple new areas and to expand overseas.
Slow progress in the Centre
Progress on implementing reform by the centre has been slow and the different ministries and SOEs have been unable to agree a detailed reform plan.
While SOE reform was highlighted in the decision document of the 3rd Plenum, the document was not clear about the purpose and direction of reform. Policy makers are unsure about whether they are expected to create a level playing field for SOEs and private enterprise, or to strengthen SOEs by making them more efficient. For example, the term mixed-ownership is not fully understood.
Furthermore, reform in this area will challenge many vested interests. Reforms will need to be led by SASAC, China’s central SOE regulator, but the nature of the reforms brings into question SASAC’s reason for existence. Moreover, the proposed reform of SOE governance systems is difficult as it will challenge the government’s power to appoint senior SOE executives.
Given these challenges SASAC has decided that the first step should be a controlled relatively small scale pilot. On July 15 SASAC announced four pilot reforms for six SOEs. The pilot will include developing state-owned capital investment companies, mixed-ownership, SOE management Board and assigning a discipline inspection team. Details about the pilot are yet to be announced, and China’s most significant monopoly SOEs like Sinopec and CNPC have been excluded.
A few centrally owned SOEs including Sinopec have decided they want to move faster. In February Sinopec announced that it would experiment with mixed-ownership on its downstream oil sales business; and CITIC Group is now listed on the Hong Kong stock exchange after being acquired by its subsidiary CITIC Pacific. However, progress on reforming the corporate governance system in these enterprises has been limited.
Vigorous reform at the local level
Local governments have been encouraged to forge ahead and experiment with different ways of implementing many of the reforms announced at the Third Plenum. And local authorities have been particularly enthusiastic about SOE reform. In the wake of the crack down on land financing and local government debt, local governments need to find new sources of revenue and to rid themselves of liabilities, at the same time as increasing productivity and easing the economic slowdown.
By the end of June, eight provinces or municipalities had announced SOE reform plans. These plans include promoting mixed-ownership, restructuring state capital and establishing different management approaches for different categories of SOEs.
And some real changes in ownership structure and governance have already started to happen. For example, in Shanghai in January Hongyi, a private equity company invested RMB 1.8 billion in Chengtou, a state-owned investment holding company. Honyi now owns 10 percent of Chengtou and has the right to participate in corporate governance.
Scepticism from the private sector
While wealthy individuals and companies are keen to diversify their investment portfolios, they tend to be unenthusiastic about the invitation to invest in often inefficient and unprofitable SOEs. Chongqing tendered 110 projects in June, but generated very little interest with investors complaining about excessively high share prices. Across China there is widespread scepticism about how much influence private companies will really be able to have over management boards of SOEs, and about how their interests will be protected.
Opportunities for the UK?
Local SASACs have been keen to emphasise to us that they encourage foreign as well as domestic investment into SOES. For now genuinely interesting commercial opportunities may be limited. However, reform, if thoroughly implemented, should lead to the opening up of state-owned monopolies creating interesting new investment opportunities and a fairer environment for all companies domestic and foreign to compete.
Disclaimer
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