The Story So Far
Reforming state-owned enterprises (SOEs) is critical to improve the competitive environment within China’s economy and in overseas markets where Chinese firms are engaged in trade and investment. Unlike other commercial entities, SOEs are tasked with economic and political objectives. The crux of SOE reform is delineating and separating these commercial and political activities.
During the 1990s, Beijing tried to reform the state sector by consolidating state control over large SOEs while withdrawing from small ones, which contributed to private sector prosperity and a decade of strong economic growth. In the 2000s, Beijing redefined SOE “reform” as concentrating state control over key and pillar industries with strategic linkages to China’s economic development and national security.
In 2013, the Third Plenum further clarified SOE reform as transforming SOEs into modern corporations, with the state exercising influence in the same fashion as other shareholders. The Third Plenum also envisioned that the state would reduce control of commercial SOEs while pushing SOEs in strategic industries to focus on their “core” business areas.
Starting in 2014, Beijing tried to improve SOEs’ competitiveness using ad hoc measures, such as mergers and mixed ownership programs (similar to those used in the 1990s) involving the sale of minority shares to private firms. These piecemeal efforts continue today. However, none of these measures has been sufficient to reshape SOEs’ incentives in line with market principles or redefine their role within the economy.
In September 2015, the State Council published a new set of “guiding principles” for SOE reform. The document was more conservative than expected. Rather than allowing the market to decide the future of SOEs, the State Council proposed utilizing market mechanisms to make SOEs bigger, stronger, and more efficient while maintaining control by the government.
The 2015 guiding principles reiterated a 2013 Third Plenum goal to transform the government’s role in managing SOEs from “managing assets” to “managing capital.” The plan was to allocate state capital toward strategic industries and reduce direct intervention in SOEs’ day-to-day operations, thereby improving efficiency. The government also stated that it would strengthen SOE corporate governance but made clear that it viewed Communist Party supervision as critically important.
Since 2017, the government has pushed to “corporatize” SOEs, including establishing boards of directors to replicate the structures of other commercial entities. But it also required all SOEs to institutionalize the role of Communist Party committees into their articles of association and give the party oversight of all strategic decisions. As a result, boards of directors still lack de facto authority to manage SOE operations.
Quarterly Assessment and Outlook
Our assessment of state-owned enterprise (SOE) reform remains negative. Listed SOEs played a bigger role in the economy in 4Q2019. Long-standing “mixed ownership reforms” saw some progress, but COVID-19 will likely delay implementation.
SOEs accounted for a smaller share of industrial assets in 4Q2019, but listed SOEs generated a larger share of all exchange-traded company revenues.
The COVID-19 pandemic has elevated the role and influence of state firms. Beijing now appears less interested in withdrawing state firm presence than in improving SOE efficiency.
This Quarter's Numbers
State-owned enterprise (SOE) reform backtracked in 4Q2019. SOEs claimed a bigger share of revenue across all sectors we track, reversing earlier improvements. State firm revenue shares increased the most in “pillar” industries considered strategic to China’s economic development (from 43.6% to 45.4%), as Beijing leaned on them to stabilize the economy late in the year (see The State’s Share). In “normal” industries where Beijing pledged to withdraw state influence, SOE revenue also increased marginally, from 15.3% to 15.8% of the total. In “key” industries considered strategic to China’s national security, the already high SOE revenue share also increased (to 83.3%).
There are indications that Beijing still intends to pursue SOE reform but has picked easier targets: restructuring unlisted firms. This is less complicated than dealing with listed firms, given regulatory requirements and potential market impacts. Industrial SOE asset growth declined from 1.3% in November 2019 to −2.4% in December, while private firm asset growth saw a corresponding uptick in December (15.1% from 13.5% in November). This likely reflects another reclassification of SOEs as private firms in December, after a previous round in August (see Winter 2020 edition). As a result, private asset share increased to 14.2% in 4Q2019 from 13.8% in 3Q2019, while the SOE asset share decreased slightly (see Industrial Assets by Ownership).
The reclassification is an ongoing story. In March 2020, the State-Owned Assets Supervision and Administration Commission (SASAC) announced that under the “double-hundred actions” campaign, 41.6% of SOE group holding companies and 62.7% of subsidiaries had achieved “mixed ownership”–adding private shareholders. More than 70 SOE group holding companies and dozens of their subsidiaries need to be reclassified, which is likely to involve several hundred billion yuan in assets. This is on the same scale as the 1.5% additional growth in private assets, which stood at 24 trillion yuan ($3.4 trillion) at the end of 2018, suggesting mixed ownership reform is the driver of this change.
The COVID-19 pandemic has changed the SOE reform landscape. In the 2013 Third Plenum, Beijing promised to reduce state influence in normal commercial industries and concentrate power in strategic ones. The pandemic elevates the role of SOEs, both politically and economically. Beijing appears less interested in withdrawing state presence and more likely to sustain SOE influence over the economy while improving their efficiency.
SOEs were central to China’s response to the virus outbreak, for example, by building new hospitals in Wuhan in just a few weeks, maintaining supplies of key materials, supporting other firms by waiving rent (or simply paying their arrears), and helping to stabilize employment while most of the private sector was forced to shut down. President Xi Jinping visited a Shaanxi automobile SOE on April 22 and praised SOEs as “the main force” in supporting China’s economic recovery. This signals that SOEs will maintain a strong presence not only in key but also in pillar industries.
The government also increasingly relies on SOEs to supplement a growing fiscal shortfall. In 2019, Beijing extracted 772 billion yuan ($110 billion) from SOEs, 120% more than in 2018. Both central and local SOEs are required to transfer 10% of state-owned equity to social security funds (SSF). By 2019, central SOEs had transferred 1.1 trillion yuan ($160 billion) in equity to the central SSF, and local SOEs are expected to transfer a similar amount to local SSFs in 2020. Increasing SOE payments to the state is a reform goal itself: as state firms, SOEs bear national financial obligations, and mandated dividend payments are supposed to instill budgetary discipline. However, this reliance incentivizes the government to shelter SOEs to protect that dividend income, especially when it cannot easily sell SOE shares at competitive prices in financial markets.
In lieu of withdrawing state influence, China announced three measures aimed at improving SOE efficiency. None appears promising. First, Beijing will establish a new central SOE, Rong Tong Asset Management Group (Rongtong), to manage defense SOEs’ commercial businesses. Rongtong leaders will still be appointed and evaluated by the state; however, their objectives are unlikely to be purely commercial. Second, SASAC is cracking down on SOE investment in non-core businesses like real estate, but enforcement is lax given the size and complex structure of SOEs. Third, on April 9, President Xi reiterated a reform plan for market allocation of production resources. But instead of reducing SOE power in non-strategic industries, the plan focuses on SOE salary reform and improving SOE corporate governance. The latter likely includes strengthening party building, which will inherently make SOEs more responsive to political priorities and less to market dynamics.
We use China’s own classification scheme to assess SOE reform progress. When information is available for listed companies, we gauge SOE revenue relative to all revenue in three clusters: (1) key industries (defense, electricity, oil and gas, telecom, coal, shipping, aviation, and rail); (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 versus private firms, SOE versus private returns on assets, SOE versus private ability to cover interest payments, and the SOE share of urban employment.