China State Companies’ Dominance Tested by Market Pledge
China’s state-owned companies, coddled by cheap credit and sheltered monopolies for years, face a less comfortable future after Communist Party leaders pledged to give market forces a bigger role in the economy.
The nation is likely to ease interest-rate and energy-price controls after the party this week assigned markets a “decisive” role in allocating resources, according to Wang Tao, chief China economist at UBS AG, who formerly worked at the International Monetary Fund. Other reform options include opening more industries to competition from private operators.
With state companies already earning less than half the return on assets of private firms, pressure could rise on enterprises from Industrial & Commercial Bank of China Ltd., the nation’s biggest lender, to phone provider China Mobile Communications Corp. At the same time, the communique from this week’s conclave in Beijing said the state would remain “dominant” and didn’t discuss specific measures.
“It’s certainly a tension,” said Klaus Rohland, the World Bank’s country director for China, based in Beijing. “State ownership in some cases may not be a bad thing, but generally an economy that is driven by state ownership is probably not the economy of the future for China, and the question then is how you get the transition right.”
Former Premier Zhu Rongji’s strategy in the 1990s of cutting the size of state enterprises with millions on the payrolls helped boost efficiency and set the stage for years of growth in excess of 10 percent.
Now the companies are becoming an increasing drag on China’s economy, with a return on assets of 4.6 percent last year compared with 12.4 percent for the private sector, Nicholas Lardy, senior fellow at the Peterson Institute for International Economics in Washington, said in a Bloomberg Brief commentary.
That gap is evident in the stock market. The benchmark Shanghai Composite Index (SHCOMP), whose biggest members include state-owned firms such as ICBC and China Petroleum & Chemical Corp., known as Sinopec, has declined 30 percent over the past three years. The ChiNext index of smaller, non-state companies has gained 15 percent.
In addition to banking and energy, China’s state-backed enterprises span power, phones, steel, autos and airlines. Companies include Dongfeng Motor Corp., Dongfang Electric Corp., Baosteel Group Corp. and China Eastern Air Holding Co.
More than one-in-four state enterprises make a loss, the World Bank and Development Research Center of China’s State Council said in a report last year. “A large share of state enterprise profits comes from a few state enterprises where profitability is often related to limits on competition and access to cheaper capital, land and natural resources,” the report said.
The plenum document “hints that the regulatory barriers that have protected state firms in some subsectors will be dismantled,” Lardy, author of books including 2012’s “Sustaining China’s Economic Growth after the Global Financial Crisis,” said. “The footprint of state firms in the economy has been shrinking” and the communique suggests that will accelerate, Lardy wrote.
Diana Choyleva, head of macroeconomic research at Lombard Street Research in London, said the plenum statement put private companies on an equal footing with state firms.
“Those in charge of the SOEs are acutely aware that once the market is allowed to set interest rates and allocate domestic resources, their game is up,” she wrote in a report.
Wang of UBS said a “decisive” role for markets means China is trying to free up prices for “production factors” including labor, capital, energy and land. Pricing shifts for natural gas, oil, coal and power are being “gradually rolled out” and will continue, while the cost of capital “will be liberated as well,” she told reporters on a conference call yesterday.
That means big energy consumers may see costs rise while companies that control resources could benefit. Letting oil producers such as PetroChina Co. and Sinopec set prices would make their profits more subject to swings in global oil prices, which is “potentially a double-edge sword,” said Gordon Kwan, an energy analyst at Nomura Holdings Inc. in Hong Kong.
China currently adjusts retail fuel prices every 10 working days based on the cost of crude.
Eliminating interest-rate controls, a process already begun with the July move to eliminate a floor on borrowing costs, may change the dynamic in the banking industry, where former Premier Wen Jiabao in 2012 called for the “monopoly” of big lenders to be broken. Consumers are burdened with caps on savings returns that keep money in official coffers, a practice sometimes called financial repression.
The deposit-rate ceiling will be eventually removed in stages, which will increase lenders’ funding costs, said May Yan, a banking analyst at Barclays Plc in Hong Kong. That will push lenders to seek better returns, which may benefit banks focused on small and mid-size companies such as China Minsheng Banking Corp. and China Merchants Bank Co., Yan said.
Some analysts took the plenum statement as doing little to indicate change in how state enterprises operate. The communique “seems to be advocating a balance” between the state and private economy, said Hao Hong, a Hong Kong-based strategist at Bocom International Holdings Co. “Keep in mind that the SOEs are big contributors to tax revenue,” Hong said.
The communique sets 2020 as a date for achieving results, which appears designed to manage expectations that reforms will be “gradual and a long haul,” said David Loevinger, former U.S. Treasury Department senior coordinator for China affairs and now an analyst at TCW Group Inc. in Los Angeles.
Elsewhere today, Hong Kong will report that its economy expanded 3.2 percent in the third quarter from a year earlier, compared with a 3.3 percent rate in the previous period, based on the median estimate in an analyst survey. Malaysia may say its growth last quarter accelerated to a 4.7 percent pace, according to a separate survey.
In Europe, October inflation figures will be released for the euro area, Poland and Austria. The U.S. publishes data on import prices and industrial production, while Canada will see numbers on existing home sales.
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