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China plots massive state sector shake-up

Reforms increasingly urgent as firms' debt swells to 50% of GDP

by Matthew Miller and Yan Huang

Reuters

Far from the spotlight, in secretive high-level meetings and company boardrooms, Beijing is drawing up one of the country’s thorniest reforms: an overhaul of China’s hugely inefficient state-owned industry.

It shapes up as an eclectic mix of pilot projects and initiatives rather than a single blueprint, which makes it harder to judge their progress than, for example, regulation-driven financial liberalization.

Yet taken together, they probably mark the beginning of the biggest revamp of China’s state sector since the late 1990s, when Beijing set out to shore up the nation’s industry ahead of joining the World Trade Organization.

In recent weeks, some of China’s top conglomerates have announced spinoffs and restructuring plans, local authorities have begun experimenting with new management structures, and political sources say a group focused on state enterprises plays a prominent role among six teams that form President Xi Jinping’s economic brain trust.

CITIC Group, China’s flagship investment company, recently detailed plans to inject its main operating business into the firm’s Hong Kong-listed subsidiary CITIC Pacific Ltd. in a $36.5 billion deal that should improve the management and outside scrutiny of the conglomerate.

During the last reform push, the government sold off or closed thousands of firms, laying off 30 million workers and cutting the number of state firms to around 110,000 from 260,000. That boosted efficiency, opened room for private businesses and cemented China’s position as the world’s factory floor.

This time, however, there is no one-size-fits-all solution.

“The situation is now different,” Li Yining, a Peking University economist and a leading advocate of privatization, told reporters last month. He said resistance from interest groups and institutional inertia are the hardest nuts to crack.

There is no question that it is time for another overhaul. In the five years since the global financial crisis, state firms have grown bigger and more dominant but also more indebted and plagued by overcapacity.

China’s 113 central government-controlled conglomerates alone have borrowed 18 trillion yuan ($2.89 trillion) between 2008 and 2013, raising their debt-to-equity ratio 40 percentage points to 192 percent. That is on top of 32 trillion yuan borrowed by 110,000 firms owned by local governments, which raised total state enterprise debt to about half of the country’s GDP.

Scaling back

Steven Sun, head of China equity strategy at HSBC Global Research, calculates that China’s state-owned firms have spent all the cash flow generated from business operations in the past five years on capacity expansion — double the ratio for nonfinancial S&P 500 companies.

“They need to scale back, and one of the best ways to do that is selling stakes to strategic investors and private capital,” said Sun.

Spearheading the government’s restructuring efforts is one of six teams named by Xi Jinping as part of his comprehensive reform office.

Membership in the group hasn’t been made public, but analysts say that Vice Premier Zhang Gaoli may be in charge.

“This economic reform team is most important, no matter who is leading the team,” said Zhang Chunxiao, an adviser to a state body that oversees the top conglomerates.

Provinces and major cities are already running trials aiming to bring more nongovernmental capital to the firms they control and embracing new management structures and incentives.

The provinces of Guangdong, Anhui, Hunan, Guizhou and Shaanxi along with the municipalities of Shanghai, Chongqing and Tianjin and the city of Zhuhai have all announced privatization plans that are likely to vary depending on firms’ role and market position.

In Guangdong, where state administrators oversee over 4 trillion yuan in assets, provincial leaders have announced they will diversify ownership in 13 sectors, including transportation, electricity, health care and mining. The goal is to bring 100 billion yuan in private investment by 2020.

Guangdong, Hunan and Guizhou are also allowing for the first time senior executives to own shares in firms they manage.

Local governments are also experimenting with using asset management companies to act like value-driven institutional shareholders rather than an extension of government bureaucracy.

In Chongqing, the government aims to transform two state firms into investment holding companies and Shanghai is set to transfer more state-owned assets to three asset management companies the city has set up since 2000.

Economists expect those local initiatives to serve as a template for national-level reforms.

Progress and resistance

Some of China’s strongest conglomerates are already reshaping their operations and ownership.

Besides CITIC, China Petroleum and Chemical (Sinopec) has announced a planned spinoff of part of its marketing arm that could raise up to $20 billion.

China’s state rail operator has said it will seek more outside investment and other big firms such as China Power Investment, and Baoshan Iron & Steel Co. are also preparing restructuring plans.

“There are many sources of income that SOEs can draw on, but if they don’t reform then income and profit will . . . probably fall,” He Wenbo, Baosteel’s chairman, said last month.

The pace of the overhaul will largely depend on Xi’s success in firming his grip on power and overcoming opposition within political and economic elites.

A political source who met Xi in private this year quoted him as saying implementing reforms had been “very difficult” due in part to resistance from state-owned firms.

Dong Minzhu, the chairwoman and president of state-controlled household appliance maker Zhuhai Gree Group, now being restructured by the Zhuhai government, voiced state managers’ misgivings about being cast as those who stand in the way of progress. “What is right or what is wrong, I really can’t say,” Dong said in an interview last month. “But if look at (who’s) paying taxes and improving the livelihood of our country, then I have to tell you that state enterprises may be better.”

Despite the resistance, many economists are convinced there is no turning back.

“Structural transformation is a huge undertaking for any economy,” said Stephen Roach, a senior fellow at Yale University and former Chairman of Morgan Stanley Asia. “In China it needs to be viewed as a journey. The train has left the station.”