Reforming China's lumbering state giants

One of the biggest stumbling blocks for economic reform in China is state-owned enterprises. Many of these companies are direct descendants of former government ministries like the petroleum ministry. Their executives still enjoy ministerial ranks and they have red phones on their desks with a direct line to some of the most powerful party officials in the country.

They are some of the largest companies in the world with market capitalisations in the trillions and they monopolise sectors like energy, resources, telecommunications and banking. Their collective assets amount to about 84 trillion yuan ($15 trillion) or ten times the market capitalisation of the ASX. State-owned enterprises account for 44 per cent of all industrial assets in China and employ nearly 40 million workers.

Yet state-owned enterprises only account for 27 per cent of the total national income and their return on assets is about 5.9 per cent. By comparison, the average return on assets for private enterprises is about 10.4 per cent. That’s a staggering result  -- especially when you consider that state-owned companies have much cheaper access to credit and enjoy a multitude of other subsidies and favourable policies.

Analysts calculate that if state-owned enterprises can bring efficiency and productivity to the level of that of their private counterparts, China’s GDP could add another two per cent. That means an additional 11 trillion yuan or $1.9 trillion, which is larger than Australia’s GDP.

Beijing has been talking about reforming these state-owned companies for years. Rounds of reform and consolidation have only made them more powerful than ever before. In China, the trend is referred to as the “state advancing while the private sector retreats”.   

Many see the state-owned enterprises as cancerous tumours that are sucking the vitality out of the Chinese economy. The sector is also a hot bed of corruption. A dozen of senior executives from PetroChina and China Mobile -- two of the largest SOEs -- have been arrested recently on graft charges.

Reform of state-owned enterprises is the litmus test of Beijing’s resolve to implement its ambitious reform program announced at the last year’s party congress which promised letting market forces to play the decisive role in allocating resources.

Is Beijing serious this time? It is too early to tell but there is a glimmer of hope.

Sinopec, one of the big three state-owned oil majors in China, has announced a far-reaching program to privatise 30 per cent of its best performing assets. The total value of assets on the auction block is about 100 billion yuan.

The news has sent shock waves throughout China as investment bankers flock to Sinopec’s headquarters in Beijing to beg for a piece of the action in this sale of the century. The sale reportedly includes 30,000 petrol stations, pipelines, storage units and 20,000 convenience stores, according to Caixin.

Why does Sinopec want to flog off its cash cow? Because it is part of broader strategy to reform the lumbering giant, which includes moves to bring in private and foreign investors, getting parts of the business ready for listing abroad and ultimately establishing independent boards for listed entities.

On the privatisation front, Sinopec’s board has agreed to sell 30 per cent of its 300 billion retail and distribution businesses. It is, in principle, open to all private and foreign investors. However, given the sheer scale of the auction, it is likely that only a handful of companies or funds have the financial resources to bid.

Fu Chengyu, the Chairman of Sinopec and arguably one of China’s most cosmopolitan SOE chief executives, said he wants to bring in outside investors to re-invigorate the company.

He reportedly said “we don’t need money -- we need vitality and dynamism.” The idea is to invite outside investors who can bring fresh ideas and a new management approach for the sprawling bureaucracy. However, some private investors are sceptical of the value of becoming minority shareholders in a state giant.

Fu promises 30 per cent of board seats for outside investors and to sell down the state’s share in Sinopec further in the future when circumstances permit. However the psychological barrier for Beijing stands at 49 per cent private/foreign ownership.

The Sinopec boss also wants to imitate a Singaporean style of managing state assets, which involves using holding companies such as Temasek to control listed entities such as Singapore Power. The model offers operational autonomy to listed companies while retaining ultimate ownership.

He wants independent boards for Sinopec spin-offs but the board of the parent company is still answerable to the Organisation Department of the Chinese Communist Party and the State-owned Assets Supervision and Administration Commission.

Richard McGregor, the author of the acclaimed “The Party -- The Secret Wold of China’s Communist Rulers” captures the hybrid nature of these state-owned beasts in a vivid way.

“Front stage, companies like Chinalco bristled with commercial ambition and traded their stock price as ardently as their western competitors,” he said, “backstage, however, the Party sat quietly out of sight, tugging on the reins when need be, safe in the knowledge it retained all the levers needed to control the company.”

Fu’s bold move to privatise the most profitable part of Sinopec is an encouraging move in the country’s decade-long fight to reform state-owned enterprises. His experiment will not be an easy one but it offers a glimmer of hope.