State Companies: Back on China’s To-Do List

Thousands of state-owned enterprises gum up the economy

A PetroChina gas station in Hong Kong on March 19, 2015.

A PetroChina gas station in Hong Kong on March 19, 2015.

Photographer: Billy H.C. Kwok/Bloomberg

In the first years of his presidency, China’s Xi Jingping left the country’s state-owned enterprises pretty much alone. Some analysts think that could change. “It’s almost certain that the central government will roll out a specific plan for SOE reform in the second half of the year,” says Zhao Yang, a China economist for Nomura.

The impact of the SOEs on private enterprise is getting more damaging as the economy’s growth slows. “Many of China’s structural distortions, both economic and otherwise, are due to the dominating positions of the SOEs,” says Chen Zhiwu, a finance professor at Yale University and an adviser to China’s cabinet in 2007. State enterprises have “made competition unfair and the legal system biased against private firms and individuals.” The 150,000 SOEs account for 17 percent of urban employment, 22 percent of industrial income, and 38 percent of China’s industrial assets, according to JPMorgan Chase. With $16 trillion in assets, the SOEs do everything from building spacecraft to trading silk. These enterprises, says BNP Paribas, are also big borrowers. BNP figures corporate debt, mostly owed by SOEs, rose to 167 percent of gross domestic product in 2014, from 97 percent in 2008. The state sector stands in the way of China’s transformation into an economy driven by services and consumption.

China’s recent stock market plunge shows how the government looks out for the SOEs. These companies dominate the stock market, and have gotten the biggest boost from government intervention. PetroChina, the biggest component of the Shanghai Composite index, has benefited from government-backed buying. Its stock jumped 19 percent in the first two weeks of July, even as the broader index sank 11 percent. Analysts say the stock was targeted for support, given its weighting in the index. One reason the government wanted a floor under stocks was to keep open a source of funds for China’s debt-burdened companies, most of them SOEs. Chinese companies announced at least $226 billion this year in initial and secondary offerings.

The return on assets of SOEs ranges from a third to half that of private companies, says Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics. “If the government wants to sustain reasonable growth, the efficiency of the state sector must improve or its size must shrink further,” he says.

In October the government will have a chance to discuss SOEs at the Fifth Plenum, when officials present the next five-year plan. In any reform, the authorities will maintain control of companies that dominate major industries such as rail, telecommunications, and energy. “Beijing will not sell its crown jewels due to their strategic importance to the Communist Party,” says Chi Lo, greater China senior economist at BNP Paribas.

Less strategic businesses in retail, construction, metals, and real estate could be in for a bigger shakeup. Options include ending direct subsidies, allowing more private investment, and promoting better governance, says Zhu Haibin, Hong Kong-based chief China economist at JPMorgan Chase.

Some progress has been made. Last year state-owned China Petroleum & Chemical Corp., known as Sinopec, agreed to sell a 29.9 percent stake in its gas station business to a group of 25 private Chinese investors. “China will not be rich being led by SOEs; it has to be led by the private sector,” says Francis Cheung, head of China and Hong Kong strategy for CLSA.

SOE reform has come in fits and starts. A push in the 1990s by then-Premier Zhu Rongji led to the closure of 60,000 such enterprises and 30 million layoffs. On a July 17 tour of state-owned clutchmaker Changchun Yidong Clutch, Xi hinted at a new resolve when he said any reform needs to be firm and fast and that state-owned enterprises shouldn’t adopt a “wait-and-see attitude.”

The bottom line: China may be getting ready to streamline, sell, or close many state-owned enterprises.

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