China's state-owned sector is strangling growth

China's underperforming state-owned enterprises not only receive disproportionate aid from Beijing, but they are choking private sector expansion. The sector is in dire need of reform.

Graph for China's state-owned sector is strangling growth

Luo Jian Chuan, Vice President Chinalco, Xiao Yaqing President Chinalco, Paul Skinner, Chairman Rio Tinto & Tom Albanese, Chief Executive Rio Tinto, at the Annual Results Announcement in London, Britain. (EPA/Newscast/John Taylor)

The listed arm of Chinese resource giant Chinalco – the largest shareholder in Rio Tinto – has been forced to sell some of its assets to stay in the black for the 2013 financial year, avoiding the fate of being treated as a pariah on the Chinese stock exchange.

Under Chinese listing rules, a company will be placed under special watch if its net profit is in the red for two consecutive years. ST, which stands for special treatment, will be added to the company’s name at the stock exchange.

Having posted a record loss of $1.44 billion for the 2012 financial year, Chinalco was desperate to be in the black this year to avoid that public humiliation.

The company was regarded as China’s national champion to take on Western resources giants. In 2008, Beijing anointed it to raid the share registry of Rio Tinto to block the potential merger between BHP and Rio.

However, the wounded national champion was forced to sell assets to its unlisted parent company to artificially inflate its bottom line. In the first half of 2013, it sold nearly 10 billion yuan of assets, but it was not enough.

The company was also forced to sell its iron ore asset in the final quarter last year for a cash infusion of $2.3 billion in order to turn a small profit of $180 million. 

Its last-minute auction saved it from joining an inglorious list of loss-making state-owned giants listed on China’s stock exchanges, including China Metallurgical Group Corporation, which is the principal contractor for building CITIC Pacific’s much-delayed Sino Iron project (China's shock and ore at the Australian way, January 9).

The worst performing centrally-owned company is COSCO, the country’s largest shipping company, which lost 20 billion yuan last year. Its Australian division is one of the few profitable subsidiaries in the world, mainly due to rental income from its office building in Sydney.

Chinalco executives have reportedly signed a written undertaking with the State Council (China’s cabinet) to return the company to profitability and some of the most senior executives have forfeited salaries, according to 21st Century Business Herald, a Chinese-language newspaper.

Chinalco’s troubles highlight one of the toughest challenges for the country’s policymakers: how to turn around underperforming state-owned enterprises that receive disproportionate resources from Beijing.

Of the 63 listed companies under credit watch, 17 are large state-owned enterprises, according to Caixin, one of China’s leading independent business publications. Seven state-owned giants sold off 30 billion yuan in assets to boost their bottom line.

Though Chinalco blames its financial woes on external factors such as slowing economy, decreasing price for aluminium products and weak consumer sentiment, the truth is state enterprises are a protected species that don’t thrive on competition and still suffer from bureaucratic mismanagement.

In contrast, the privately-owned Shandong Weiqiao, which also manufactures aluminium products, has been enjoying record levels of profitability, despite tough market conditions. Its gross profit was around 30 per cent in 2012, according to company reports.

Qiu Lin, an industry analyst, compares Chinalco’s quasi-bureaucracy to Weiqiao’s streamlined management structure. Chinalco employs about 90,000 people,10,000 of whom are administrative staffs. The ratio of production staff to management is about eight to one.

At Weiqiao, the company employs 16,700 production workers, 3,950 technicians and 334 managers. The ratio is about 62 to one. Chinalco, a supposedly modern listed company, is still run like a government bureaucracy.

The state-owned sector is also plagued with corruption issues. Chinalco’s former senior vice president Li Dongguang is under investigation for alleged corruption. Many senior executives from PetroChina and China Mobile – two of the largest fortune 500 companies in the world – have also been arrested recently for disciplinary infractions, a codeword for corruption.

One of the most disappointing features of China’s otherwise bold reform blueprint unveiled at the third plenum of the Eighteenth Party Congress is on reforming the state-owned sector. It is not only inefficient but also choking a dynamic private sector of precious resources for further expansion.

Follow Peter Cai on Twitter: @peteryuancai

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