China's looming SOE reform wave - part II

Moves to reform SOEs have faced push-back in the past, but Beijing's latest steps to overhaul the state sector could have more success this time.

This is the second part of a two-part series. Part one is available here.

A comprehensive plan outlining how China’s policy makers aim to overhaul the country’s state-owned enterprises (SOE) could emerge as soon as October, according to recent reports in Beijing.

Pushing ahead with reform of the state-owned economy was a key theme in the ambitious blueprint for economic reform published at the conclusion of a pivotal meeting of the Communist Party leadership late last year.

Some analysts have been underwhelmed by the detailed policy announcements that have emerged since last year’s “decision.” For instance, the recent announcement of a pilot reform involving a few centrally-controlled SOEs by the State-owned Assets Supervision and Administration Commission (SASAC), the ministry-level body charged with both managing and supervising some of China’s largest and most powerful state owned firms, have led some to conclude that serious reform is no longer on the agenda.

However, it’s still too early to write-off the potential for “top-level” reforms to the SOE sector.  Comprehensive reforms are still on the agenda and they will be guided by significant shifts in top-level policy settings. That said, the implementation of these significant reforms will be both cautious and contested and is unlikely to begin before 2015.

Cautious and Contested

On the sidelines of a meeting of China’s National parliament in March this year, Xi Jinping was quoted as saying that the success or failure of the mixed-ownership reforms (changes that will allow more private capital to invest in state-owned firms) will depend on how exactly they are carried out.

Implementation of SOE reforms will be similar to the recently announced changes to China’s household registration system, another key area of reform that was flagged at last year’s plenum. That is, despite ambitious long-term reform goals, initial changes to policy will be tentative.

This caution is connected to a fear of repeating the mistakes of the last big “privatisation push” which involved the widespread appropriation of state assets at unfairly low prices. Given the politically-sensitive nature of the reforms, the central government wants to be sure that a system is in place to handle the transfer of state assets in a fair and transparent manner.

The push to reform SOEs is also likely to face push-back from local governments and political interests aligned with state-owned firms. Many of the recent attempts to open up more sectors of the economy to competition and to improve the management of SOEs have stalled, with many chalking this lack of progress to the political strength of “interest groups” who benefit from the current arrangements.

Reasons for Optimism

However, there are a few reasons why this latest push to overhaul the state sector might have more success.

Firstly, through his anti-corruption drive and by assuming leadership roles in many of the powerful new institutions charged with driving the reform process, President Xi Jinping appears to have taken firm control of the party’s reform agenda.

For example, senior executives who had served at the top of China’s oil and gas oligopoly and went on to assume very senior political positions have been detained by the party’s powerful discipline inspection commission - including “tigers” such as Zhou Yongkang, who served on the Politburo Standing Committee, and Jiang Jiemin who had moved on to head up SASAC. Many analysts argue that one of the key motivations for these takedowns was to weaken the influence of a major obstacle to reform. The successful removal of these powerful figures will help in overcoming any remaining resistance to the reform agenda.

Secondly, SOE reforms are to be implemented at the same time as other major reforms to the economy are being carried out. Some of these reforms will make it easier for private companies to compete with state firms on a more equal footing and thus put pressure on SOEs to be more efficient and competitive. For example, as part of financial sector reforms, the market will play a greater role in setting interest rates and state-owned banks will be exposed to more competition, which will in turn help to reduce the amount of cheap finance available to SOEs. Similarly, planned changes to how key resources are priced will also limit SOEs access to cheap inputs. Likewise, if the government is able to push ahead with reforms to the taxation system that result in local governments being provided with sustainable tax revenue, this too could help reduce their reliance on local SOEs as a source of income and thus reduce their incentive to oppose reform.

Finally, given the weakness in the broader economic environment and the troubled financial positions of many SOEs and local governments, state firms that might have been reluctant to relinquish control, or even a stake, to private investors, now have a powerful incentive to take part in the reform process.

Indeed, it’s exactly on this point of “mixed-ownership reform” that much of the current internal debate seems to turn. Driven by a need to alleviate immediate financing concerns, many state firms and local governments want to limit reforms to a simple broadening of the scope for private capital to investment in SOEs. Those with a broader reform agenda are arguing that the overhaul of the SOE sector has to go beyond simply offering SOEs a new avenue for fund raising and needs instead to involve a major overhaul of the distribution, management and supervision of these state-backed firms.

Whatever the eventual outcome, the release of the guideline policy documents in coming months will be an important turning point as it will determine the terms on which this high-stakes political debate over the optimum level of state ownership is fought. The challenge for the government will be to prevent cautious implementation from slowing momentum to such an extent that reforms stall. 

Paul Pennay is a Melbourne-based writer and former editor of the Economic Observer's English website.