Promise & Peril of SOE Reform in Mainland China

♠ Posted by Emmanuel in at 2/29/2016 06:15:00 PM
There are approximately--count 'em!--150,000 state-owned enterprises (SOEs) in the PRC. When discussing SOE reform, the natural tendency will be for readers to think of privatization. Thousands upon thousands of SOEs are now being loosed from government controls? Think again. China being a practitioner of gradualist tinkering with the economy, the government has announced a scheme that does not go all the way. Rather, China will experiment with allowing SOEs more leeway in business decision-making instead of clearing all and sundry actions with government officials.

However, this (somewhat) increased amount of discretion comes at a certain price, once again demonstrating that there is no such thing as a free lunch--even in the PRC. China will no longer as readily extend credit from government banks if these firms encounter duress if they are categorized as "commercial" entities:
China announced last year it would kick off the process of overhauling state companies by categorizing them into commercial or public-service entities, a move that’s prompted many SOEs to seek discussions with regulators over how they should be classified, according to four people familiar with the matter. These talks are bound to heat up in Beijing this week at the National People’s Congress, the Chinese government’s biggest gathering of the year, according to three of the people.

For China’s many SOEs -- JPMorgan Chase & Co. has estimated there are more than 150,000 of them -- the stakes are high. Being branded as commercial could lead to higher salaries in some sectors and less government meddling but also deprive a company of cheap financing and state protection in the event business sours, as is increasingly the case in China’s slowing economy.
The upshot is that SOEs classified as commercial enterprises will be pressured to show more profits in exchange for this increased independence:
"This categorization will impact SOEs and their business models because commercial companies will face higher pressures to make profits and public ones will need to focus on social benefits," said Zhou Jingtong, Beijing-based director of macroeconomic research at Bank of China Ltd. "It will also influence investor decisions when they buy SOE bonds and shares because commercial companies will be riskier options."

The likelihood of government support is already factored in for some SOEs’ debt ratings. For example, Standard & Poor’s rates Aluminum Corp. of China Ltd., China Railway Group Ltd., China General Nuclear Power Corp. and Citic Group Corp. as investment-grade issuers although each would be rated junk purely based on their financials, according to a S&P report in January.

The idea behind the dual categorization, announced in September, is for the government to control public-interest companies and turn the rest into more market-oriented firms by loosening oversight and making them accountable for their performance. Most SOEs will be categorized as commercial, the people familiar said.
It's another step in the road to China turning into a market-based cconomy the rest of us will recognize, replete with "shareholder" capitalism and such. As per traditional criticisms of state-owned enterprises, their dynamism has been found lacking in China compared to their entirely private counterparts in terms of generating returns--on assets, for example--and the state is seeking to inject some of this dynamism:
Though individual cases vary, SOEs as a whole are ripe for reform. While they generated profits of 2.3 trillion yuan ($352 billion) in 2015 -- more than South Africa’s entire economy -- that’s still down 6.7 percent from a year earlier and those returns were only 1.9 percent of the 119.2 trillion yuan in assets they held, according SASAC figures.

Industrial profits at SOEs have also fallen for 14 straight months, while the last time earnings declined in the private sector was more than three years ago. SOEs are also less adept than private companies in cutting debt, according to research at the Chinese University of Hong Kong.