China’s SOE reform

February 2015  |  FEATURE  |  FINANCE & INVESTMENT

Financier Worldwide Magazine

February 2015 Issue

February 2015 Issue

China’s economic growth has been one of the key developments of recent years. However, while the speed of the country’s economic revolution has been breathtaking, recently it has begun to slow. Partly as a result, attention in Beijing has turned to the country’s many state owned enterprises (SOEs). SOEs have been the undisputed fulcrum of Chinese economic growth. Recent figures suggest that the total asset value of central and local SOEs is about $16.33 trillion.

As the Chinese economy has begun to slow, the government has been forced to act. Conceived during the third plenary session of the central committee of China’s Communist Party in November 2013, China has introduced the concept of mixed ownership to its SOEs. According to the Party, mixed ownership will involve “cross holding by, and mutual fusion between, state-owned capital, collective capital and non-public capital”.

The overhaul of China’s SOEs is already well underway. In Q3 2014, two significant deals were completed which saw over $50bn worth of assets changing hands. Sinopec Limited sold a $17.4bn stake in its retail unit to a group of domestic investors, while the Citic Group transferred $37bn worth of assets into a Hong Kong-listed unit, a move which saw the metamorphosis of one underperforming subsidiary into a financial powerhouse seemingly overnight. Though one of those deals took the form of a spin off, it is evident that more fundamental changes to China’s SOEs are occurring. Going forward, these reforms will have a significant impact upon the wider Chinese economy. The changes were proposed as the government looks to reduce the level of losses incurred by the country’s SOEs, while increasing competitiveness and productivity.

Regardless of their performance in recent years, it is important to note that China’s SOEs have played a significant role in the country’s economic growth over the last decade. Indeed, SOEs were responsible for the astonishing speed at which a number of key infrastructure projects were completed across China. Furthermore, a number of the country’s smaller SOEs have been influential in other non-core, non-infrastructure industries.

However, the SOEs, which have previously been granted privileged status in China, have begun to drag back the national economy. Accordingly, the Chinese government has identified a group of six large SOEs which will participate in a pilot scheme which has been designed to attract greater private investment and improve corporate governance.

An overhaul of the country’s SOEs could well play a key role in cementing its economic standing.

Outside the SOE community the reforms have been welcomed. In December, Moody’s Investor’s Service pledged its support for the reforms. According to Moody’s, the move will be largely credit-positive for China’s SOEs. “The SOE reforms will improve SOEs’ corporate governance, supplement capital and enhance SOEs’ operational efficiency, although negatives include the increased return of state capital gains to the public fiscal account and more competition as private capital enters previously monopolised sectors,” said Kai Hu, a Moody’s vice president and senior credit officer. “Key initiatives in the government’s reforms include redeployment of capital to key areas, away from industries not strategically important. Shanghai, for example, targets to deploy 80 percent of state capital investment in strategic emerging industry, high-tech manufacturing, infrastructure and social welfare sectors.”

In addition to ownership structures, the reforms will influence a number of other areas within SOEs. As such, they are unlikely to be popular with many in the SOE community. In August, for example, China’s President Xi Jinping ordered salary cuts for top SOE executives. Despite the reservations, the Chinese leadership appears determined to overhaul the status quo.

In many respects, China’s network of SOEs mimics pre-privatised Europe of the 1980s, with the majority of the country’s key assets under state control. Yet while the privatisation of European assets was a relatively smooth process that unlocked significant value across a number of sectors, the introduction of mixed ownership is unlikely to be as trouble-free in China. The existence of a well- established private sector in Europe helped to facilitate the sale process, whereas in China the program of SOE reform is occurring concurrently with the development of both the country’s private sector and an institutional capital market. Consequently, the timeline for SOE reform is likely to be a long one.

Further reforms are expected to be announced during the first quarter of 2015. These reforms should provide encouragement for the private sector and solicit further investment into key SOE-dominated industries, such as telecommunications and infrastructure.

With the Chinese economy predicted to overtake the US in the coming years, an overhaul of the country’s SOEs could well play a key role in cementing its economic standing. Chinese economic and corporate development is at a crossroads. By embracing substantial private investment in a cadre of SOEs, the Chinese government could usher in the next period of Chinese economic prosperity.

© Financier Worldwide


Richard Summerfield

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