x Abu Dhabi, UAESunday 21 January 2018

The economic ‘vampire squid’ threat to China’s vitality

For the country's economy to prosper and keep growing, some of the capital hogged by the huge state-owned enterprises must be diverted into the private sector. Time will tell whether the new administration will go ahead with the reform.

A welder at a site for a new train station in Ningbo, China. The power of China’s state-owned enterprises makes it difficult for private entrepreneurs and SMEs to thrive. Reuters
A welder at a site for a new train station in Ningbo, China. The power of China’s state-owned enterprises makes it difficult for private entrepreneurs and SMEs to thrive. Reuters

BEIJING // There is growing consensus among economists and strategists that for China to keep its remarkable rate of growth intact, Xi Jinping's government must do more to smash the monopolies enjoyed by its gargantuan state-owned enterprises (SOEs).

SOEs make up more than half of Chinese economic output and employment. Of 70 Chinese firms on the 2012 Fortune Global 500 list, 65 are state-owned.

By the end of last year, China had 117 central SOEs, which held assets worth 28 trillion yuan (Dh16.52tn). Most of the centrally administered SOEs are in the sensitive industries of energy, telecoms, transportation and defence.

At last month's 18th Communist Party Congress, where Mr Xi took over from Hu Jintao as the party chief and head of the army, ahead of a full transition in March, Mr Hu spoke of the need to "deepen reforms" and said part of this was the need to "unwaveringly consolidate and develop the public sector of the economy, and deepen reforms of SOEs".

For China to truly thrive, some of the capital currently being hogged by the SOEs needs to be channelled into the private sector. And the SOEs themselves need more transparency, better supervision and people other than senior Communist Party cadres need to be appointed to senior management roles.

In his book No Ancient Wisdom, No Followers: The Challenges of Chinese Authoritarian Capitalism, James McGregor examines the degree of influence exerted on the domestic economy by the SOEs.

"For the past 10 years, the SOEs have reported more to the party than they have to the government. In that way they've been like the military. The SOEs are a powerful force within the party and that means that the party can make change happen," said Mr McGregor.

The power of the SOEs is driving private entrepreneurs and people starting small and medium-sized enterprises (SMEs) out of China.

"When wealthy people start getting out, it's a bad indicator. They don't feel safe, they don't feel confident. Entrepreneurs need a nod and a wink," said Mr McGregor.

It's tough for Chinese SMEs to compete. The SOEs have easy access to cheap credit because no one wants to refuse credit to a company backed by a senior local cadre, and they tend to suck up all the available capital.

This needs to change, said Mr McGregor. "Look at Deng Xiaoping in the late 1980s. Who did he turn to to pull China out of the morass? The entrepreneurs. The past 15 years have been good for state industry, building up infrastructure. But now it's time for the party to pivot in the same fashion Deng Xiaoping did in 1978/79. The party needs to head in another direction. We need to go back to a new version of Deng Xiaoping," said Mr McGregor.

SOEs feature heavily in an HSBC report last month called "China's Big Bang" looking at how the potential problem of China's debt could be resolved. One of the options put forward was the sale of state assets by local governments to raise funds to repay loans.

HSBC said local governments still own more than 20,000 SOEs, of which 70 per cent are profitable.

The need to reform the SOEs may be forced on the government.

Profits fell 8.3 per cent year on year to 1.75 trillion yuan in the first 10 months of the year, the ministry of finance said in November. Earnings at centrally administered SOEs were down 3 per cent, while at SOEs under local governments profits decreased by 19.3 per cent.

This February, the "China 2030 Report" was released, a joint effort by the World Bank and the Development Research Centre, a think tank with links to the State Council, China's cabinet.

This presented a sweeping reform agenda, including interest-rate liberalisation and limits on the power of SOEs.

"In the enterprise sector, the focus will need to be further reforms of state enterprises (including measures to recalibrate the role of public resources, introduce modern corporate governance practices including separating ownership from management, and implement gradual ownership diversification where necessary), private sector development and fewer barriers to entry and exit, and increased competition in all sectors, including in strategic and pillar industries," it said.

Mr McGregor believes the fact that incoming premier Li Keqiang has been involved in the China 2030 report, and the Five-Year Plan, which began last year, is a signal of reform in China.

SOEs account for most of China's outward direct investment (ODI). Last year, about 90 per cent of ODI flows came from big SOEs, while private enterprises accounted for a marginal share. In cumulative terms, SOEs have accounted for about two thirds of total ODI.

They have also been active in many sectors, such as mining.

Led by SOEs such as Sinopec, PetroChina and Chinalco, Chinese companies have sped up the pace of acquiring overseas mines.

According to the Chinese Academy of Social Sciences, a Beijing-based think tank, over the past seven years they have made more than 91 overseas mining acquisitions worth 199bn yuan.

"State-owned enterprises are China's economic version of the giant vampire squid," John Foley said in a recent Reuters commentary.

"The 20,253 industrial companies owned and controlled by the government soak up capital, and pay little out. Their costs are low and their bosses powerful … if the squid isn't tamed, it will suck the vitality out of China's economy."

Wang Yong, the head of the State-owned Assets Supervision and Administration Commission, said that the SOEs should learn from private and foreign companies to be more market-orientated.

"We could learn from multinational companies and some privately owned companies at this point.

"We have to stand out among the market competition and create more benefits for employees and shareholders," Mr Wang said during last month's 18th National Congress of the Communist Party of China.

"We have to continuously deepen the reforms. This could help us add vitality and enhance SOEs' influence," he said.

SOEs must shift their business model to a more market-orientated one.

"China's SOEs shoulder some responsibilities that should have been borne by local governments and society, and this has added to their operating costs and hurt their profits," said Mr Wong.

The outgoing premier Wen Jiabao said the government was committed to breaking the monopolies.

"We must move ahead with reform of the railway, power and other industries, complete and implement policies and measures aimed at promoting the development of the non-state economy, break monopolies and lower industry thresholds for new entrants," he said.

The message of reform is clear from the outgoing administration, now the question is whether the newly installed administration under Mr Xi follows through.