Bosses at top state-owned enterprises, or SOEs, are all about control. On the occasions that they have had to let go, such as when big firms were listed on capital markets in the early 1990s, they fought hard to ensure outside investors got little say in management.
This is one of the biggest obstacles to shaking up governance and ownership of top SOEs, which the current administration is pursuing with a vigor not seen since those days. Back then President Jiang Zemin and his reform-minded Premier Zhu Rongji broke up thousands of state factories as they decisively smashed China’s “iron rice bowl.”
Nobody is expecting a similarly brutal tactic during this latest round of reform to be deployed on the SOEs that survived that blood bath. Experts have come to see tactical, nuanced moves that bring in capital or expertise but retain state control.
A landmark deal involving China’s first SOE to be run on market-like principles has been heralded as a blueprint for state enterprise reform in the Xi Jinping-Li Keqiang era. Shareholders in Hong Kong-listed Citic Pacific recently approved the company’s plan to buy the key operating assets of parent Citic Group for US$36 billion. These include lucrative stakes in financial services providers such as Citic Securities and Citic Bank.
“Listing most state owned assets in domestic and overseas exchange [without relinquishing state control points to] the direction for future SOE reform,” Kai Hu, a senior analyst with ratings agency Moody’s in Hong Kong, told China Economic Review.
As the largest ever capital injection by an SOE into an overseas-listed unit, observers ponder the Citic deal’s significance. They note that Citic Group was at the forefront of Chinese economic reforms. Under the guidance of Rong Yiren, an illustrious “red capitalist” who won the trust of the Communist Party, the company spearheaded China’s first efforts to attract foreign investment within Deng Xiaoping’s plan to let market forces into a then undeveloped economy. Now it is the biggest financial conglomerate in China.
Experts see several positive outcomes from the news. The inclusion of private shareholders into Citic Group’s assets “will [also] at least improve its transparency” – not something SOEs enter into willingly. Listing in Hong Kong will also mean the assets are subject to more stringent disclosure requirements and better corporate governance.
High profile institutional investors that bought into a share offering from Citic Pacific to fund the deal should also add a counterbalance to the state’s control. In the event that Chinese policymakers support projects that could “destroy the value of the company … there will be pressure from [its] financial shareholders,” Hu said. These include influential government bodies such as the National Social Security Fund.
The unique nature of the backdoor listing of Citic Group through the asset injection, which is the practical result of the transaction, suggests this could be a model for future shakeups in the ownership of state enterprises.
So, is this the answer to arguably the biggest economic question facing the government since the 2008 financial crisis: How to retain a heavy government hand in SOEs even while making them more market-oriented? Or in other words, how can the state spread prosperity without giving up control of China’s economy?
Leaders appear to think it is, at least for now. Many large SOEs including China Mobile and Sinopec have listed in Hong Kong and New York over the past two decades as part of government-designed restructuring. The rebirth of capital markets on the mainland in the 1990s wasn’t designed to improve governance or profit investors.
With the economy sputtering policymakers recognize the benefits of unlocking growth in SOEs that sit on juicy, strategic assets from energy to utilities. The language of the Third Plenum talked of the market having a “decisive” role in SOEs; this year more and more state projects have been opened up. But the need for public control remains critical.
Beijing has decided that state firms will continue to be the backbone of China’s economy, ratings agency Fitch said in a report last week, and therefore “there is a low likelihood of the state relinquishing its control over the large and strategic SOEs in this round of reforms.” In fact, the central government will “solidify their status as linchpins of the economy” through preferential policies, an age-old habit that is dying hard.
The Citic Group transaction not only retains state control of Citic Pacific, but will actually increase it. Beijing’s stake in the listed unit will rise from 58% at present to 82% upon completion. This doesn’t look much like reform anymore.
Critics of the state sector say it is inefficient. The purpose of opening up ownership to private, and eventually foreign, investors is to maximize returns on assets. Governance of state giants must also be tightened to prevent catastrophic financial losses. Citic Pacific burned US$ 2 billion in 2008 after an executive made unauthorized currency derivatives transactions. Flabbergasted investors had believed that supposedly responsible management at a listed firm would reduce the risk of such an event.
This deal does not look like it will achieve either – or that it is even trying to. Neither will the market be given a chance to price SOEs fairly. Beijing forbids state assets to be sold at below book value, regardless of the trading price of the firms that control them. State investors in Citic Ltd. such as the social security fund don’t like to lose money, but they are also operated at the behest of the state and are unable to ignore Beijing’s directives.
What initially appeared to be a step towards change now looks more likely a clever illusion as the arms of the state continue to grip hard onto government companies.