China's looming SOE reform wave

It’s easy to lose sight of the wood for the trees when it comes to tracking progress in efforts to reform China’s state-owned enterprises (SOEs).

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

However, since then, detailed policy announcements have been cautious and piecemeal, with various local governments and individual SOEs appearing to take the lead on announcing “mixed-ownership reform” plans that allow greater levels of private investment in state firms. While the State-owned Assets Supervision and Administration Commission (SASAC), the ministry-level body charged with both managing and supervising many of China’s state-owned firms, has limited itself to unveiling a lackluster pilot reform involving a few centrally-controlled SOEs.

Despite the lack of central direction and bold initiatives, local media reports suggest that comprehensive reforms are still on the agenda and that they will be guided by significant shifts in top-level policy settings.

Why they need to reform

There are several key reasons why policy makers have determined that the management and regulation of China’s state-owned firms need to be improved.

The first is that since the financial crisis, SOEs are looking increasingly inefficient in terms of profitability and the rate of return on equity and assets. This poor performance is beginning to act as a drag on the economy’s potential for growth just as broader structural changes are shifting China’s economy onto a slower growth trajectory.

Another reason is that their preferential access to subsidised energy, land and capital inputs is leading to severe market distortions that have resulted in rampant overcapacity in some key sectors.

A third motivating factor is the external pressure being placed on China’s government as state-owned firms seek to integrate more fully into the global economy by investing and competing abroad. China’s trading partners have complained for years of the preferential treatment enjoyed by state-owned firms.

How China plans to overhaul its state-owned firms

The National Development and Reform Commission and the Ministry of Finance are taking the lead on policy formulation in relation to SOE reform and are currently in the process of finalising the details of three “top-level” policy documents that will serve as the basis of reform of the state-backed sector out to 2020. The policy guidelines will then be passed to the newly-formed “Central Leading Group for Comprehensively Deepening Reform” for approval.

Up until now, much of the focus of both domestic and foreign media had been on the “mixed ownership” reforms mentioned above. While it is clear these measures will be a central feature of the plan, the reforms are going to involve a lot more than simply pushing ahead with diversifying the ownership of state-owned companies.

There are four other main features of the reform plan.

One of the most important initial steps will involve the classification of a state-owned enterprise according to whether it functions as a “public service,” a “natural monopoly” or as a “commercial enterprise.” This classification process will define which sectors SOEs should operate in and will help to inform the process of setting the level of holdings that private companies can have in various types of SOE. The process of classifying SOEs provides the central government with an opportunity to fundamentally redefine the areas of the economy that it believes state-owned firms should operate in. It also allows the state to more accurately target its investments in areas it deems are of strategic value.

Secondly, the procedures for evaluating and supervising state firms will be improved and specifically adapted to the type of SOE involved. This will apply to things like how the hiring and salary packages of employees are regulated and also the rollout of independent boards and other measures depending on the type of company and the sector in which it is operating.  

The government has also said that it plans to establish new asset management firms to allow the state to own a stake in firms at one remove. What some have referred to as a move from “managing SOEs to managing state-owned assets.” Others have called it the Singapore model.

Finally, the plan calls for a further expansion in the number of SOE that are required to transfer dividends to the Ministry of Finance and a further hike in the proportion of profits that handed over to the state. The government also plans to use more of the revenue raised through the collection of such dividends to fund social services. Currently, over 70 per cent of these funds go back to “restructuring other SOEs.”

What to look for

The implementation of these significant reforms will no doubt be cautious and contested. However, there are a few reasons for optimism.

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.

If the central government is able to make progress in classifying China’s state-owned firms into different categories, this could add a level of sophistication to the debate over the role of the state as it will force proponents of a larger state to argue their case on a more detailed basis rather than in the abstract.

The extent to which any strategic or “pillar” industries are off-limits to foreign or private investment will also provide a clear indication about the future of China’s industrial policy and also how serious policy makers are about allowing market forces to play a larger role in the economy.

Also, given that the NDRC and the MOF have been given the responsibility of taking the lead on drafting the policy documents, it’s likely that there will be major changes to both the role and relative authority of SASAC.

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

*This article is the first of a two-part series. Part two will be published tomorrow.