SOE Reform

China's SOE reform gathers pace

Sinopharm and China National Building Materials are next in line for further privatization as Beijing revamps its debt-laden state sector.
President Xi Jinping spearheads reform
President Xi Jinping spearheads reform

Sinopharm and China National Building Materials (CNBM) are next in line for further privatisation, Chinese officials said on Tuesday, as the country pressed ahead with sweeping reforms of its bloated state-sector.

In all, six companies were singled out as potential test cases for the rest of the Chinese economy, including State Development & Investment Corp (SDIC); Cofco; China Energy Conservation and Environmental Protection (CECEP); and Xinxing Cathay International. 

China’s Communist Party, more than ever before, is embracing private sector investment in its SOEs in the hope that mixed ownership will make these economic linchpins more efficient and in so doing cut general debt levels and prop up growth.

“If it gets implemented, the magnitude of change is very significant,” Wei Sun Christianson, co-chief executive of Morgan Stanley in Asia excluding Japan told FinanceAsia in an interview.

President Xi Jinping first unveiled his plan to court private investment at a Communist Party leadership gathering in November. Asset sales at centrally governed financial and industrial giants have quickly followed. Beijing-based conglomerate Citic Group sold 16% of its capital to 27 institutional investors after injecting $36 billion of its assets into a Hong Kong-listed entity, while Sinopec wants to sell up to 30% of its retail unit by the third quarter and PetroChina is looking to sell more of its pipelines.

Now a further six companies are being pushed forward by the State-owned Assets Supervision and Administration Commission of the State Council (SASAC), the supervisor of China’s largest SOEs, because they have already made some solid progress towards reform. 

“We hope these test cases will advance broader SOE reform in an orderly manner,” Peng Huagang, a senior SASAC official and a member of the regulator's reform committee, said in a statement after a press conference in Beijing. 

Courting private capital

SASAC said that CNBM, a cement-to-engineering business, and healthcare group Sinopharm are slated for more private ownership, partly to improve management. They already have listed subsidiaries. 

China has been gradually shifting from a Soviet-style centrally planned economy in the 1970s to a more market-oriented one. In this latest round of reforms, China has placed more emphasis on hybrid ownership with big strategic private investors rather than the more diffuse ownership sought during the privatisation of China’s big SOEs between 2003 and 2010, where discreetly owned stakes were typically less than 5%.

“Now we’re talking about a private placement process where big stakes in SOEs could change hands,” said Morgan Stanley’s Christianson. “China is saying for the first time 'come and take a look, you can buy significant and strategic percentages of state-owned enterprises'.”

Big stick

SASAC will also station disciplinary teams at two or three SOEs to root out any corruption. This is part of a broader anti-corruption drive sweeping across China as the administration looks to clean its house and quell distrust and unrest among the country's middle classes.

So far, during the most recent clampdown, 31 SOE senior executives, including 20 chief executives, have been sacked due to losses or corruption, according to state-run daily newspaper The Beijing News. In one case China’s anti-graft agency is investigating Song Lin, Chairman of China Resources. 

CECEP and conglomerate Xinxing Cathay, alongside Sinopharm and CNBM, are earmarked for a management overhaul, which will involve them having more independence from SASAC to hire new executives, shake up performance reviews and create more effective financial incentives.

In addition, SASAC has selected SDIC, one of China's largest state-owned investment holding companies, and China's largest grain producer Cofco to trial ways to make SOEs use state money more efficiently and profitably. The regulator will give them both more independence over investment decisions in the hope that it might help lower general debt levels.

SOE leverage ratios have been rising rapidly. HSBC calculates that the sector's average debt-to-asset ratio is about 65%, above the 40% to 60% range widely seen as acceptable by private investors.

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SASAC is encouraging other SOEs to submit proposals for reforms.

The potential impact of SOE reform on the economy is massive. There were 113 SOEs controlled by SASAC at the end of 2013 and about 145,000 SOEs under local government control.

The total assets of non-financial SOEs were worth Rmb91 trillion ($14.6 trillion) at the end of 2013, or 160% of Chinese GDP, according to analysts at Credit Suisse.

It won’t be plain sailing for SASAC. Sections of the Chinese press are already decrying the government’s willingness to sell assets cheaply and the potential loss of SOEs as policy tools, such as Cofco’s role in stabilising food prices. Management buyouts were curbed in 2006 after academics lobbied against selling assets at bargain-basement prices.

But Beijing’s determination and motivation to push through change is clear. SOEs suck up cheap funding from banks and are responsible for many of the country’s non-performing loans. In 2009, for instance, SOEs received around 85% of bank loans in China, distorting the economy.

“We want to find and resolve problems in SOEs," said SASAC's Peng. At the same time, he added, “we need to prevent any activity that may lead to the loss of state assets during the SOE reform.”  

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