Minding China's business

China's State Council has approved a plan by the State Assets Supervision and Administration Commission (SASAC) to create a new asset management company under its control, called Guoxin Asset Management Corp., according to reports in Chinese media in recent days. The SASAC was created in 2003 to play the role of investor on behalf of the government in state-owned enterprises (SOEs) and to manage their reform. The SASAC was charged with restructuring and consolidating the massive state-owned sector, responding to demands of both the central government and the Communist Party on how to govern this sector.

China's economic transformation in recent decades has required it to go to great pains over SOEs. In the Maoist era, China's industries were taken over and operated by the state, but this gradually changed as China sought market-oriented reforms beginning in the 1980s. In the mid-1990s, after a massive bout of inflation that was fuelled in great part by wasteful SOE spending, the Chinese government under Premier Zhu Rongji moved to cut down the SOE sector. This resulted in more than 40 million lost jobs, but it helped correct one of China's deepest structural flaws and paved the way for a surge in private enterprise, mostly export-oriented manufacturers on the coasts that became the biggest source of employment in China.

Nevertheless, SOE reform was never finished and China retained a sprawling state sector that was increasingly uncompetitive and dependent on subsidies and government-provided credit to survive. Since the sweeping reforms of the 1990s, SOE reform has moved only incrementally. Currently, the SASAC has two state asset management companies, the State Development and Investment Corp. and China Chengtong Group, both of which were created in 2005 to help consolidate the SOEs. In this reform process, the goal is ostensibly to separate the profitable units from the unprofitable ones, with the profitable units spun off and the unprofitable units subject to mergers and management changes to focus on the areas in which they are competent.

The advantage of this strategy is that it attempts to salvage productive sectors from a larger morass of inefficiency, state dependency and corruption. The disadvantage is that the consolidation process results in behemoth SOEs that are not well integrated or able to function as a whole, but that have a greater concentration of political power – mainly due to their $US3.3 trillion worth of sales in 2009, and their role as major employers – and are able to preserve aspects of the state sector from private competition, demand continued public funds for support, and serve as vehicles for government officials' pet projects, in turn squeezing private sector development.

A recent emphasis for the SASAC has been ensuring that capital is allocated efficiently amid the massive increase in bank lending in 2009 and 2010 launched by the central government to stimulate the economy during the global slowdown. Not only are a number of state-owned assets mismanaged – for instance, being directed by government officials rather than businessmen – but many, especially on the local level, do not even have clear managers. The huge infusion of credit nationwide has likely led to a range of ill-conceived investments (including illegal speculation in equity and property markets by subsidiaries of SOEs) and the SASAC is responsible both for supervising these investments and containing any problems, as well as reporting and demoting corrupt officials and employees.

It is not clear yet how Guoxin will operate – some reports claim it will act like the sovereign wealth fund China Investment Corp., but rather than investing China's foreign exchange reserves, it will handle domestic investments of assets in the industrial sector. Other accounts say Guoxin will simply join the other two asset management corporations overseen by SASAC in consolidating the SOE sector. The number of centrally controlled SOEs stands at 128, down from 196 when the SASAC reduction targets were set in 2003. Guoxin is to be responsible for further consolidation, taking over at least 12 smaller SOEs and helping the SASAC reach its goal of reducing the number of SOEs to 100 by the end of 2010, and eventually down to 80.

STRATFOR will continue to watch the developments related to the SASAC's new creation and overall SOE reform.

Stratfor provides intelligence services for individuals, global corporations, and divisions of the US and foreign governments around the world.