CHINA: SOE reforms to create national champions

Analysis

The goal of state-owned enterprises (SOE) reforms has been twofold: to reduce the burden that their losses placed on the state budget and the domestic financial sector; and to bring market forces to bear, to which they would respond by investing in value-enhancing technologies and production methods, achieving world-class competitiveness.

Emphasis has been given to achieving economies of scale and scope. By the late 1980s, numerous more or less ad hoc linkages had developed between large enterprises, a. tendency later formalised by the selection of 120 trial business groups called the National Team. They were the focus of reforms that included:

• the development of internal group finance companies;
• stock-market listing;
• preferential planning;
• increased decision-making autonomy;
• rights to incorporate state assets;
• the creation of research centres; and
• rights to conduct foreign trade.

These groups were given special financial assistance, direct state investment and protective tariffs support. They accounted for over 50% of total industrial profits by the end of 1996.

Selection of preferred groups has also taken place at province and city level, and by 1999 about 2,300 enterprise groups were so registered. The groups consist of a core company and layers of companies in which the core has a controlling or minority share. This structure creates nationwide networks, helping enterprises to circumvent local government structures that might intervene in decisions and to operate across a national market that has traditionally been subject to local protectionism. It has also helped to create the conditions needed to compete in the context of the progressive opening of the domestic market, under the terms of China's WTO entry in December 2001.

Consolidation. In 1997, the state-led campaign to bring about the consolidation and merger of SOEs and eliminate the problem of their losses started in earnest. As a result:

• The number of state-owned and state holding industrial enterprises (listed enterprises in which the state has a controlling share) fell by 46% between 1995 and 2000, to about 50,000, during which period their net profits rose from 83.81 billion renminbi (10.16 billion dollars) to 220.93 billion renminbi.
• The number of small and medium-sized SOEs (SMEs) fell from 245,000 to 149,000, with their losses of 50.2 billion renminbi in 1998 transformed to profits of 28.69 billion renminbi in 2002.
• The number of large enterprises (defined in terms of assets or volume of output), most of which are also SOEs, rose from 7,558 in 1998 to 8,752 in 2002. The share of large and medium sized enterprises in total sales, profits and capital assets rose from 44%, 70% and 69% of the national totals in 1998, to 61%, to 69% and 76% in 2002.
• In 2004, SOEs accounted for about 40% of industrial value added.

SASAC. Since 2003, supervision of the very largest SOEs has been the responsibility of the State-owned Assets Supervision and Administration Commission (SASAC), a State Council commission which takes the role of beneficial owner of all state assets, exercising direct control over about 180 large SOEs from Beijing, with branches throughout the country.

In 2004, the SASAC noted that of the 14 mainland Chinese enterprises listed in the July Fortune 500, eight were under its direct supervision, mainly in the heavy industry and telecommunications sectors (see CHINA: Vested interests hamper telecoms reform - January 25, 2005). China now wants 50 Chinese companies in the top-500 by 2015. However, SOEs remain small by international standards and their financial performance lags, despite large increases in profits in 2004. Large SOEs spend on average only 1% of their operating income on R&D, compared with about 5% for multinational companies.

Finance problems. Access to finance can be difficult, especially for smaller enterprises.

• State banks, still burdened with large portfolios of non-performing loans (NPLs), are risk averse and preoccupied with preparing for the WTO-mandated opening of the whole domestic financial market in 2006.
• Measures to cool investment in 2004, including higher interest rates and credit controls, hit smaller companies hardest.
• Access to capital markets, especially the stock markets, is reserved for the few; the bureaucratic hurdles are high and stock markets have continued to perform poorly.

About two-thirds of stock market capitalisation is locked up in government-held non-tradable shares and fears that some of this might be offloaded periodically depress the markets (see CHINA: No resolution in sight on non-tradable shares - August 10, 2004). A second board, for SMEs, has been launched, but has yet to make an impact. Many profitable SOEs are subsidiaries of parent-companies that have absorbed large amount of underperforming assets while restructuring, and this impedes prospects for initial public offerings (IPOs) in China and overseas.

Governance issues. The decision-making process in SOE-management and SOE balance sheets are opaque. How chief executives are appointed, removed and rewarded by the state are major questions; politics seem to loom large. Revelations about large-scale tax evasion and corruption by senior SOE managers continue.

Employment. Employment opportunities outside the SOE sector have increased as the economy has diversified, but providing jobs for a workforce that rises by about 10 million new entrants per year is a major challenge (see CHINA: Labour market remains underdeveloped - October 8, 2004). Since 1997, SOEs have laid off millions of workers; some have found work in the collective or private sectors of the economy; but there are millions of unemployed workers. The SOE sector employed 57% of the urban industrial workforce in 1998, which had fallen to 41% by 2002, still a large proportion. There are still many thousands of surplus workers in SOEs, and particularly in SMEs that fall under the control of local authorities, who continue to subsidise such enterprises -- often by directing local banks to offer finance -- rather than bear the welfare burdens consequent on closure.

New initiatives. Among the initiatives already announced or expected soon are:

• legislation on management buy-outs in smaller scale SOEs;
• replacement of 'policy-led bankruptcy' (where the state directs the process) with 'bankruptcy by law', with legislation expected by mid-year;
• extension of performance targets set for 30 large SASAC-controlled SOEs, with contracts signed by their chief executives, to other SOEs;
• asset-management companies to assume and dispose of non-performing assets of SOEs;
• tax incentives for debt-to-equity swaps;
• the Corporation Law amendment to make it easier to set up new businesses; and
• a comprehensive system of unemployment insurance to replace ad hoc arrangements.

Details on many of these policies are still awaited, as are timetables for implementation. However, they reflect the government's determination to press on with industrial restructuring in which large-scale privatisation is not a priority.