China's SOE revamp could lead to problems

Chen Zhiwu, a member on the international advisory board of the China Securities Regulatory Commission, says diversified ownership could increase corruption.

A plan to diversify the shareholder structure of state-owned enterprises (SOEs) will be a temporary solution for their overcapacity issues and may trigger problems, according to Chen Zhiwu, a member on the international advisory board of the China Securities Regulatory Commission.

The plans, unveiled in the third plenum of the 18th Central Committee last November, encourage SOEs to sell stakes to the private sector and diversify their ownership structure as part of broad efforts to open up China’s markets.

Introducing private capital into SOEs should help companies improve profitability and efficiency, Chen told FinanceAsia at China’s annual Boao economic forum.

However, private investors can only take a minority stake so they are not able to have a final say in running the businesses. The leaders of large SOEs are normally nominated by the authorities and they often come from positions in the government.

“To what extent the private capital can play a bigger role is still uncertain. It’s hard for the private sector to gain power to make overall change in the SOEs,” said Chen, who is also a professor of finance at school of management with Yale University.

Furthermore, the introduction of private capital may give SOEs more leverage room and generate more debt and overcapacity if there is little change in corporate management and governance, said Chen.

Without any supervision on the state power in SOEs, the companies may continue to make the same mistakes in only targeting expansion rather than efficiency, and creating corruption and unfair competition, which will generate worse atmosphere for the private sector, according to Chen.  

Smaller investors may not be able to have the chance to participate in SOEs according to the current reform plans, said Chen. Those big insurance companies and private equity funds who have built a good relationship with the SOEs or governments have more opportunities, leaving little room for open competition.

SOEs, especially those in sectors such as energy and power generation, have suffered low growth and overcapacity during the past few years.

“They are growing dramatically in asset size but unable to make profit,” said Chen.

SOE stocks are poorly traded in capital market because of their worsening financial matrix. For example, China Petroleum & Chemical Corp (Sinopec), Asia's biggest oil refiner owned by the Chinese government, once traded at Rmb29.3 in 2007, but now only at Rmb5.4. During the same time period, the company’s revenue has doubled from Rmb1.2 trillion to Rmb2.8 trillion, while its net profit only rose 22% from Rmb54.9 billion to Rmb67.2 billion.

“The SOEs have to improve their poor financial performance while [maintaining asset size]. They don’t have much choice but to sell their assets to the private sector to make a better ROE or ROA (return-on-asset),” said Chen. 

Some have already taken the move. Sinopec is planning to sell at most 30% of its retail assets to social and private capital for $30 billion, the largest asset sale by a Chinese state-owned company, according to company statements and media reports.

Chen believes in a free market and is encouraging full openness of SOEs to the public. But full privatisation or a majority control by the private sector is out of Beijing’s consideration because the government and the management of SOEs do not want to lose control, said Chen.

He said hybrid ownership is a passive choice for the companies because they have no better choices; it should be a temporary solution but can never be the ultimate resort for Chinese SOEs’ problems.

The comments from Chen, an adviser to China’s government and several large SOEs, are a timely counterweight to the excitable reaction within capital markets following Beijing’s promise to release more reform measures to boost economic growth.

China’s Premier Li Keqiang yesterday reaffirmed in the Boao Forum more openness and structural reforms, as well as the central government’s commitment to foster a consumer-led economy and support the private sector.

On the same day, the Shanghai and Hong Kong stock exchanges announced a mutual market access plan, which allows them to invest up to Rmb300 billion ($48 billion) in each other. The plan has secured regulatory approvals and will launch in six months.

The Shanghai composite index rose 1.9% while the Hong Kong market 1.1% yesterday upon the news.

“Premier Li promises more financial liberalisation while the mutual access between the two stock exchanges implements the guideline in a practical level. Both events boost market sentiment,” Li Jian’ge, vice chairman of Central Huijin Investment and chairman of Shenyin Wanguo Securities, said on a Boao discussion panel moderated by Jame DiBiasio, FinanceAsia's editorial director.

Some market experts and investors believe the new round of reforms, including allowing the private sector play a more important role in the economy, will boost China’s economic growth and bring lots of opportunities for capital markets.

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