China's SOEs - Economic revolution or noose around the neck?

Even as the leadership in China consistently maintains that state-owned enterprises (SOEs) are the "root and soul" of the country's economic well-being, a difference of opinion appears to have surfaced between President Xi Jinping and Premier Li Keqiang

According to the Xinhua news agency, while President Xi maintains that the ruling Communist Party of China (CCP) must continue to have a robust and tight grip on these institutions, Premier Keqiang is of the view that while SOEs are an important foundation for national development, there is an urgent need to reform them as "languid mechanisms and poor management have resulted in declining profits".

 

This difference of opinion, according to observers and analysts, suggests that China could either be heading for a major economic overhaul or revolution, or end up tying a noose around its neck.

Both President Xi Jinping and Premier Li Keqiang are on record as repeatedly highlighting the "unique advantage" that these state-owned enterprises offer and provide, but it seems to observers that they are following different paths to ensure the continued relevance of these institutions.

At a recent two-day work conference, President Xi was quoted by the Xinhua news agency, as saying, "We must unswervingly uphold the party's leadership in state-owned enterprises, and fully play the role of party organs in leadership and political affairs," and adding that there was no scope for "weakening, fading, blurring or marginalization" of the CCP's authority."

In President Xi's assessment, all SOEs have a primary role in implementing his visionary "One Belt, One Road" strategy and describing them as useful for spreading communist ideology beyond China's borders.

In light of his comments, many have been left questioning what direction China's SOE reform plan will take?

China instituted a sweeping reform plan three years ago during the Third Plenary Session of the 18th Party Central Committee - the "Guiding Opinions of the CPC Central Committee and the State Council on Deepening the Reform of State-Owned Enterprises".

A large part of the plan was for SOEs, a.k.a. yangqi in Chinese, to become more efficient as the state sector slowed.

However, President Xi seems to be wavering on embracing such reforms.

The CCP, therefore, has to decide whether to maintain control or to liberalize markets.

Observers and analysts believe that a clearer picture on the way forward could emerge when members of the Standing Committee of the Politburo become known next year.

The merging state business has continued since the time of President Hu Jintao.

Under Hu, the number of yangqi fell from 200 to 114, and Xi is trying to reduce the number below 100. However, these merger decisions come from the top down rather than from sensible bottom-up business needs.

There are some who believe that this merging of state companies to create even bigger entities is counter-intuitive to improving efficiency as it reduces competition and decreases profitability.

Chinese finance ministry data backs this contention. Up till the end of September, the combined assets of SOEs totaled RMB129 trillion (a figure 2.5 times GDP). However, the return on these assets fell to 1.3 percent, compared with 1.9 percent at the end of 2015.

It indicates that these corporations are a drag on the economy as they suck in credit and accumulate debts.

Some economists have warned that a tepid approach to reforming of SOEs pose the biggest risk to China's economy, as they currently contribute around 25-30 percent of industrial output.

Though reform is on the minds of the Chinese leadership, there is also a fear of powerful business empires being built that could affect the country's political landscape.

The CCP cannot and will not allow this, at least under the present dispensation, as can be seen from President Xi's wide-ranging anti-corruption campaign wherein several executives in oil, telecom and steel companies have been caught and punished.

SOEs have enormous economic influence. If subsidiaries are counted, there are an estimated 1,50,000 state-owned companies in China employing more than 30 million people.

In the first half of 2016, the gross revenue of SOEs reached RMB21.39 trillion, more than 60 percent of the national GDP.

There are more than 100 Chinese companies in the Fortune Global 500 list, although only a few are private businesses.

The aforementioned "Guiding Opinions" document categorized yangqi into two groups: for-profit entities and public welfare (i.e. commercial and public classes). The former will become more market-based, while the latter will provide better services to improve quality of life. They will follow dual-track reforms.

Will China promote mixed ownership, a euphemism for partial privatization, -- that is the question upper most in the minds of a majority.

Analysts predict China will waver between state ownership and mixed ownership, rather than go in for full privatization.

A Chinese University of Hong Kong study has said that reforming SOEs could ensure some amount of progress, but the overall impact will be limited.

"Without getting into full swing, the goal of this round of reforms might just be another fantasy for the Chinese economy," it said

Wendy Leutert, in a Brookings Institute report entitled 'Challenges Ahead in China's Reform of State-Owned Enterprises', described three challenges to reform: determining how and when to give market forces a greater role, aligning mismatched executive incentives and overcoming complicating factors within firms.

Firms are administered by the State-Owned Assets Supervision and Administration Commission (SASAC). SOEs are divided into two kinds according to their importance and size. The core group of around 50 includes giants such as Sinopec, State Grid and China Mobile, and they are ranked at the vice-ministerial level. The remainder is a mix of global industry players such as Sinosteel, these ranked at the department level.

Consolidation has long been China's favored method of reform. Often it aims to avoid competition between Chinese companies so they are not bidding against each other in overseas tenders. Mergers are attractive because they avoid having to sell off state firms, which could create unemployment, and keeps them well within the CCP's orbit. State ownership is supposed to be a pillar of domestic stability, and social unrest caused by mass unemployment is anathema to the CCP.

It may be noted that President Xi's top economic advisor, Liu He, has urged the government to implement a pilot reform program for mixed ownership among s strategic industrial sectors such as electricity, petroleum, natural gas or railways.

Such dominions have long been described as "untouchable", so the ambition to change their model of operating certainly is a clear indicator that the government is determined in its efforts.

However, there are certain areas China will refuse to hand over control, defense being one example. The country is already paranoid about foreign influence and spying, so this is another serious impediment to opening up corporations.

Leutert concluded regarding commercial SOEs, ".It remains to be seen whether government-directed reforms can improve firm performance if mixed ownership and market influence on company restructuring, operationsand management stay minimal.

The CCP must leave enough room for itself to back out of anything that devolves authority. This raises huge questions about the actual feasibility of implementing market reforms.