State-owned enterprises (SOEs) are a large and ingrained part of China’s economy. For that reason, leaders have worked to improve SOE performance and to reform the sector for decades. Much change has in fact occurred, but the meaning of “reform” has varied through the years. For former Premier Zhu Rongji in the 1990s, SOE reform meant consolidating state control over large SOEs and withdrawal from small ones, which contributed to private sector prosperity and a decade of economic growth. In 2006, the State-owned Assets Supervision and Administration Commission (SASAC), the central nonfinancial SOE owner and overseer formed in 2003, redefined SOE reform as an effort concentrated on seven key industries where the state would retain a dominant role, and nine pillar sectors where the state would “direct” development. President Xi Jinping’s 2015 SOE reform vision stresses managing SOEs based on their “core” industries: those in normal commercial industries should decrease state ownership and maximize profits; those in key industries and pillar sectors should separate commercial and strategic business lines; while those providing public services should focus on cost control and service quality.
We use China’s own classification scheme to assess SOE reform progress. For listed companies where information is available, we gauge SOE revenue relative to all revenue in three clusters: (1) key industries (defense, electricity, oil & gas, telecom, coal, shipping, aviation, and rail – a new one vaguely referred to as a key industry in recent years); (2) pillar industries (autos, chemicals, construction, electronics, equipment manufacturing, nonferrous metals, prospecting, steel, and technology); and (3) normal industries (tourism, real estate, general manufacturing, agriculture, pharmaceuticals, investment, professional services, and general trade). As SOE reforms are implemented, the state firms’ share of revenue should at a minimum decline in normal industries – those that Beijing has identified as suitable to market competition as the decisive factor. To supplement this primary indicator, we look at the share of all industrial assets held by SOEs, leverage ratios at state vs. private firms, SOE vs. private return on assets, SOE vs. private ability to cover interest payments, and the SOE share of urban employment.
Quarterly Assessment and Outlook
Beijing committed to reducing its presence in competitive sectors in the Third Plenum Decisions in 2013, including by selling down state-owned enterprise (SOE) shares in many industries and improving SOE management and operational efficiency. The government is committed to dominating key industries that are critical to national security, but its heavy footprint in a broader set of emerging manufacturing and services sectors generates myriad inefficiencies, stifles fair competition, and ultimately threatens the country’s longer-term economic health. The willingness of the state to reduce its role in sectors that should be governed by market competition is therefore a vital barometer of China’s reform process. Our primary indicator looks directly at the state’s share of revenue in a range of sectors in the Chinese economy. The dataset for our primary indicator is incomplete in this review period. But our read of available data and our supplemental indicators suggests that SOE reform remains stalled. The share of revenues captured by listed SOEs likely held stable in normal and pillar industries or moved only slightly for cyclical reasons, even though the state should be withdrawing from these segments. Other indicators show that mixed ownership reforms, meant to inject private capital into SOEs and improve operational efficiency, made no discernable progress in improving management, and that SOE leverage ratios did not improve. Data transparency regarding SOE performance actually deteriorated as the National Bureau of Statistics (NBS) adjusted some data streams and stopped reporting others, all without explanation.
The recently concluded National People’s Congress (NPC) was a missed opportunity for the government to present new designs or concrete implementation plans for SOE reform. The NPC did enhance the authority of the National Audit Bureau to supervise state firms, but this was done to strengthen supervision and improve performance rather than to drive fundamental reforms in the state sector. In January, the NPC’s Standing Committee also mandated that the State Council report to it on SOE performance annually, with a first round of reporting set for October 2018. Increased supervision may hold SOE managers more accountable for corporate performance but also risks stifling reform experimentation. As of the drafting of this Dashboard edition, the Party’s newly elevated Financial and Economic Affairs Commission (formerly a so-called leadership small group) signaled that SOEs would be a focus of deleveraging efforts in 2018. This could potentially mean a reduction in SOE debt risks this year depending on the intensity of those efforts. However, the broader set of needed structural reforms to the state sector remains stymied by turf battles and institutional constraints. All signs point to a quiet year for SOE reform in 2018.
The recently concluded National People’s Congress was a missed opportunity for the government to present new designs or concrete implementation plans for SOE reform.
This Quarter's Numbers
Data for our primary indicator on SOE reform, which looks at the share of revenues captured by listed SOEs in three industry categories, are incomplete because many companies did not finalize 2017 year-end financial reporting as of our drafting of this edition. But based on companies that have reported so far, and other related evidence, we see no meaningful reduction in the state’s share of revenues in almost all the industries we monitor. This suggests that SOE reforms, which should be reducing the state’s share of the take, are not moving meaningfully. The share of revenues for SOEs in key industries may have declined slightly as the National Development and Reform Commission (NDRC) investigated SOE price collusion and moved to restrict anticompetitive practices by local governments (see Competition Reform). But the SOE share of revenues in pillar and normal industries, which are more central to our assessments, probably held stable or moved only slightly (up in pillar and down in normal) for cyclical reasons related to production cuts and the property market.
If reforms were having their intended effects, the share of revenues captured by SOEs in normal and pillar industries should be falling. We use normal industries as our primary benchmark because Beijing does not assign any priority industrial policy status to these sectors. Last quarter, we noted that the share of revenues captured by listed SOEs in both normal and pillar industries decreased modestly as more private firms were listed on China’s stock exchanges, which by definition increased the share of revenues held by private companies. But this effect softened in 4Q2017 as regulators tightened screening for IPOs. Only 85 new companies were listed in the review period, down from an average of 100 to 130 in the previous three quarters. Some local governments (e.g., Shanxi, Shandong) issued plans for provincial SOE restructuring, but given the heavy schedule of political events during this review period (from the 19th Party Congress in October to the Central Work Economic Conference in December), these plans were given lower priority and not implemented.
Two items may drive some variation in our primary indicator when full data are available. First, the share of revenues captured by SOEs in normal industries might have softened somewhat in the review period, as financial deleveraging efforts pressured real estate SOEs to sell property holdings, and the government directed them to enter the less profitable rental market. This happened even as private firms increased profits by selling more properties in smaller cities. If this trend is verified when more data are available, and holds up over future quarters, it could represent real improvement. But we cannot conclude that based on the limited data available to date.
Second, environmental policy enforcement and a broad-based slowdown in the property market hurt the construction sector, where private firms tend to exhibit more volatility in profitability than SOEs, which benefit from preferential funding access and priority status in government procurement. This may modestly drive up the share of revenues captured by SOEs in pillar industries, which would not be movement in the desired direction.
We will be able to offer more definitive conclusions on these issues in the next Dashboard edition. Regardless of the data limitations this round, our supplemental indicators reinforce our analysis that SOE reform progress has stalled. Mixed ownership reforms, meant to inject private capital into SOEs and improve their corporate governance, did not appear to have any impact on SOE governance despite official assurances of progress. Serious mixed ownership reform would reduce the level of companies and assets controlled by the state, but the share of SOEs in overall industrial assets in China declined by only 1% in the review period – well below the declines exhibited in 2014 when mixed ownership pilots were initiated (see Industrial Assets by Ownership). Other indicators show that state firms are only getting stronger in some sectors: production capacity cuts in heavy industries, part of the supply-side structural reform (SSSR) agenda, and related environmental efforts effectively reduced supply. But this ironically boosted prices and improved SOE return on assets (see SOE Return on Assets) and interest coverage (see SOE Interest Coverage Ratio) during our review period. This appears to flatly contradict stated aspirations to reduce the state’s share of profits in these sectors. And even with improved profits, SOEs were not able to attract new private capital or improve operating efficiency. As supply catches up to demand in heavy industries and price effects wear out, these indicators of return on assets and interest coverage will likely deteriorate (producer prices dropped to 3.7% in February 2018, from an average of 6.3% in 2017).
Finally, SOE Leverage fell slightly but remained high at 60%. Persistently high SOE debt reflects an inefficient misallocation of capital to the state sector and elevates financial risks. Beijing recognizes this, but the data show the government is not making sufficient progress toward its stated goal of deleveraging SOEs. At the present rate of deleveraging, it will take SOEs 10 years to descend to Chinese private company levels of indebtedness.
Transparency about how SOEs are performing also deteriorated in the review period – a worrying development. We rely on industrial financial data published by the NBS to compare SOE performance with that of private companies. But in January the NBS adjusted down the total revenue of China’s industrial sector in the fourth quarter of 2016 by 10%, so that yoy revenue growth in the fourth quarter of 2017 was 6%, instead of the -23% it would have been if 2016 were not revised downward. Adjustments in NBS data are not uncommon, particularly when smaller firms report year-end revenues. But radical changes of this magnitude are rare and deserve explanation, yet none was given. Also, in February, the NBS stopped reporting the value of fixed asset investment (FAI) for private companies, making it impossible to verify reported growth rates. China’s FAI data are notoriously unreliable, yet the sudden change in approach also came with no explanation from NBS.
The March 2018 NPC was a missed opportunity for Beijing to unveil new thinking on SOE reform. The government’s work report for the year committed to “deepen trial reforms in state capital investment and management companies” and to “prudently move forward with reforms introducing mixed ownership in SOEs.” Neither is a new initiative; both are consistent with stated goals from the Third Plenum Decisions in 2013. The legislature also empowered the National Audit Office to oversee SOE managers. This appears meant to strengthen Party supervision of SOE performance, not to drive reform implementation.
A flurry of new SOE reform designs was announced during the fourth quarter, but regulatory redundancy and overlap were unresolved – meaning that SOE reforms remain convoluted and distracted by conflicting interests. The November meeting of the Party’s then Leading Small Group for Comprehensively Deepening Reform (its first after the 19th Party Congress in October) approved a proposal to have the State Council report SOE performance to the NPC every year. SOE performance has always been a part of the State Council’s annual work report to the NPC. But the new mechanism formalizes that reporting and specifies priority issues including valuation, legal compliance, reform progress, and implementation of the Party’s strategy. This list makes clear that financial performance is only one of a broader set of agenda items the government considers in managing and evaluating SOEs. The first round of reporting will be in October 2018, with particular focus on financial SOEs.
In November, the Ministry of Finance (MOF) also required all central and local SOEs to transfer 10% of their state equity to social security funds (see Labor Reform). This move is long overdue – having state firms return more dividends to the government, rather than using all profits to reinvest in their own operations, is a long-standing goal. President Xi announced the explicit goal of increasing SOE contributions to public budgets during the Third Plenum reforms in 2013. The November announcement will likely take years to implement given that fewer than 10 SOEs began trials last year and the government set no hard deadline for compliance. The NDRC also pushed more mixed ownership pilots in the fourth quarter, but no new details on the mechanism were announced nor any additional trials finalized.
Finally, regulators signaled that reducing SOE debt will be a policy focus in 2018. Beijing’s newly elevated Financial and Economic Affairs Commission stated this April that deleveraging efforts, which focused on the financial sector in 2017, would focus more on SOEs and local governments in the year ahead. In January 2018, the State-owned Assets Supervision and Administration Commission, which oversees SOEs held by the central government, announced a new target for a 2% reduction in overall SOE leverage over the next three years. This should not be a major challenge given that SOE leverage fell by 1% in 2015 alone (though it has not improved significantly since). Leverage rates may decrease this year depending on the intensity of deleveraging efforts, and as local governments consider state asset sales to alleviate bleak fiscal conditions (see our Fiscal Affairs cluster). These would be positive outcomes for SOE reform and would be captured in our indicators in future quarters.