The year of the monkey is looking like it will be the year that China privatizes the majority of its remaining state-owned enterprises (SOE) by allowing, and indeed welcoming, unprecedented private and foreign ownership.
China's nominally communist government is using the inherently capitalist economic terminology of 'the market' to push forward its agenda and, by doing so, rid itself of the vestiges of the command economy.
This will provide immense opportunities for both foreign and domestic companies, as enterprises and assets are put up for sale and gaps appear in various markets as state companies retire from the scene.
But privatization (a word very rarely mentioned publicly in China) will aggravate the problems that the government is most sensitive to, by adding to the numbers of unemployed and increasing the potential for the corruption that has been all too common throughout China's recent history.
The government entity responsible for state-owned enterprise reform is the Stateowned Asset Supervision and Administration Commission (SASAC) and the leading figure in the privatization charge is Li Rongrong, the minister in charge of the commission.
SASAC was set up in April 2003 and was handed direct responsibility for managing 196 of China's largest 'core' SOEs and for setting policy for the rest. While the government will undoubtedly retain control over key strategic sectors, even these core SOEs are not completely secure.
"All of these 196 must be major market leaders," Li Rongrong said at SASAC's first international conference. "I'm giving the management two years to show progress. If they can't make it, I'm going to restructure them further or sell them. My goal is to pare the 196 down to 30 to 50 groups that will be major multinationals."
The conference was hosted jointly with the United Nations Industrial Development Organization (UNIDO) in the Great Hall of the People, one of the most potent symbols of Chinese socialism, and was entitled the 'International Merger & Acquisition Summit, 2003'. The choice of topic was a clear indication in itself of the commission's China is acutely aware of the problems that occurred in Russia's privatization process, which saw the country's major industries transformed into massive oligarchies that challenge and undermine the power of the state. But the Chinese government is faced with a potentially bigger problem – the debt-ridden and rickety state-owned banking system which props up the entire Chinese economy.
Why sell the SOEs?
"The government has made it clear that it wants to deal with the sale of SOEs quickly and also that it wants to quickly clean up the financial sector by dealing with the country's massive non-performing loans. Actually these two issues are closely related," said Ivan Chung, Managing Director of Xinhua Far East China Credit Ratings.
It is no secret that China's banks are technically insolvent because of massive loans made to SOEs for political rather than economic reasons. Because of the legacy of the centrally planned economy, China's SOEs are for the most part inefficient dinosaurs employing far too many people and generally losing far too much money. The banks continue to lend to them because of these companies' importance to the government, because of existing political connections and to slow the process of workers being laid off. As a result, China's banks are saddled with a debt of gargantuan proportions – somewhere in the order of 50% of the country's GDP, or about RMB 5.5 trillion (US$664.5 billion) in 2003.
These non-performing loans (NPL) are viewed as the biggest threat facing the Chinese financial system and the economy at large and the government has pledged to clean up the sector while at the same time fixing the problem at the source – by cleaning up the SOEs.
And that is where the government's real problem lies. In order for the SOEs to be fully 'rationalized', many more citizens will have to be sent to swell the ranks of China's unemployed, thereby increasing the potential for serious social unrest. Since China began restructuring its economy on a large scale in the 1990s as many as 45 million state workers have lost their jobs.
If the regulatory framework is too lenient and sales of SOE assets are conducted too quickly, there is a huge potential for corruption and layoffs that would lead to serious social instability. It is for this reason that national regulations on the sale of SOEs contain clauses stating that employees must be taken care of.
On the other hand, if the process of selling off the remainder of China's non-strategic SOEs is hindered by too many regulations, it will be very hard to find buyers and the problems will fester. "The Chinese would be delighted to have a massive sell-off of SOEs, but a lot of these companies you couldn't give away," said Professor Kenneth Lieberthal, Special Assistant to the President and Senior Director for Asian Affairs at the National Security Council during the Clinton Administration.
Lieberthal said that even though the government is not setting a minimum price for the sale of state assets and even though it looks ready to permit foreign and domestic investors to restructure companies once they have acquired them, the fact is that some of these companies will be best dealt with by knocking down the buildings and redeveloping the land.
'Grasp the big…'
The government is facing a bigger problem than it did in the mid-1990s when it introduced the policy of 'grasping the big and releasing the small' in regards to the sale of state-owned assets. In practice this meant transferring control of smaller SOEs to the provincial governments who could be relied on to sell off a certain number of them, usually through management and employee buyouts (MBO and EBO).
"This form of privatization was politically and economically very easy to do because insiders at the firms were very keen on it and local officials couldn't be accused of allowing local capitalists to take over the companies – it was 'the people' who were buying the companies," said Stephen Green, Head of Asia Program at the Royal Institute of International Affairs in London and author of the recently released book China's Stockmarkets.
China's business press heralded 2003 as "the year of the MBO" but in early 2003, the Ministry of Finance issued an edict that temporarily brought MBO activities to a halt, citing widespread corruption and insider manipulation.
"There's been the realization that it doesn't work," said Green. "Management tend to sell themselves the company at very low prices."
Many of China's smaller SOEs was not set up until Aprilhave already been sold or merged but there remain a large number of companies the government would like to have off its books. According to official statistics, the number of SOEs fell from 262,000 in 1997 to 159,000 in 2002. In order to dispose of the majority of the remainder, the government has decided it is time to 'release some of the big' along with the remainder of the small SOEs.
The legal and political groundwork for the acceleration of SOE sales was actually laid at the 16th Communist Party Congress in November 2002, when legislation was passed to encourage the transfer of all but the most strategic state assets to domestic and foreign investors. But large-scale privatization didn't happen in 2003 for a number of reasons, said Patrick Norton, managing partner for the Beijing office of O'Melveny & Myers law firm.
"SASAC was not set up until April and then SARS hit a couple of weeks later. No serious efforts were made to privatize anything until late summer 2003," he said.
Then, on October 14, 2003, the Communist Party's Central Committee passed a resolution that quietly called on the party to push ahead with privatization and cleared the way for the sale of medium and large state-owned enterprises.
"After more than 20 years of market reforms, especially after the fast growth of the past 10 years, and in light of the policy changes after the 16th Party Congress, we feel it is time to accelerate the pace of the sell-off of SOEs to private and foreign investors," said SASAC head Li Rongrong. "Only through reform can we have development. Isolation leads to stagnation, and the key reason for M&As is to increase the productivity and profitability of our enterprises."
The new policy meant the party had decided that in order to retain a key role in the economy, it must sell parts of its biggest companies to foreign or private companies.
Li predicted China was entering a "a peak period of mergers and acquisitions" because local governments, which manage about 90% of China's state firms, have been granted more authority to dispose of the businesses.
"This is a major ideological breakthrough. It's essentially a declaration of mass privatization," said Fred Hu, a managing director of the Goldman Sachs investment bank. "In my own discussions with a lot of senior policymakers, my impression is they've made up their minds."
At the same time as it is privatizing the bulk of the SOEs, SASAC is working to push the worst performers out of business entirely. "There is still a bulk of enterprises that need to be closed down," said Li. "We will work hard to spend another five years to make those enterprises that are qualified for closure and bankruptcy quit the market."
From TVs to airports
There were already concrete signs of the quickening sell-off towards the end of 2003. In November, Sichuan and Yunnan provinces announced they would be putting 1,000 SOEs up for merger and acquisition (the preferred euphemism for the politically sensitive 'privatization') by private domestic and foreign investors in 2004. In Sichuan these companies included Changhong Electrics, one of China's largest television makers, and Wuliangye Distillery, a diversified drinks maker. The total assets of companies up for grabs in Yunnan alone come to RMB 110 billion (US$13 billion).
In mid-September, the State Council approved the transfer of 93 of China's 140 civil airports to the various authorities of the provinces, cities and regions. Despite having assets worth RMB 40 billion (US$4.83 billion) the airports are losing a lot of money and are being transferred in the hope that they will be quickly sold off to private and foreign investors.
In the financial sector, BNP Paribas created modern China's first wholly foreignowned bank in early December by buying out the share of its state-owned JV partner Industrial and Commercial Bank of China (ICBC).
And late last year the Ministry of Construction announced a long list of urban infrastructure projects, previously monopolized by the State, that are now open to all investors.
"The word strategic is becoming less and less meaningful, and the basic approach is, whatever the private sector can do better, the government should get out of," said Fred Hu from Goldman Sachs. These infrastructure projects involve hundreds of billions of RMB and include port construction and management, urban road construction, water supply, gas and heating systems and waste treatment in most medium and large cities nationwide.
In Shenzhen, for example, the government is negotiating to sell a big stake in its water company to the French conglomerate Veolia, the world's top water firm (formerly known as Vivendi), and the sector has also drawn interest from No 2 player Suez of France and Singapore's SembCorp Industries.
Shopping for an SOE
About 20 or so asset exchanges have been set up by SASAC around the country and it is at these exchanges that the majority of SOE sales are expected to occur. The asset exchanges basically act as dating agencies matching suitable buyers and sellers.
Shanghai and Beijing have already released regulations on the sale of SOEs and Shanghai has effectively set up a one-stop shop for the sale of non-listed SOEs where private domestic and foreign purchasers can get everything from asset valuations to government approval for an SOE sale.
In addition, the four asset management companies responsible for selling the nonperforming loans (NPL) of China's 'big four' state banks are also posting their NPL portfolios at these asset exchanges. Li Rongrong and SASAC are also explicitly encouraging the transfer of non-tradable state shares in the larger companies that are listed on China's stock markets (see Page 20, China's stock markets) to domestic and foreign buyers as another form of privatization.
In December the Beijing exchange even held its first China State Owned Assets and Equity Exchange Fair. Since its founding in April 2003, SASAC has approved the sale of 48 enterprises worth RMB 22.5 billion (US$2.7 billion), with 83% of the assets going to domestic private enterprises. But as the privatization speeds up a higher proportion of foreign investors are expected to be involved in these transactions.
The government would be pleased if they could sell off prime assets to domestic investors but in many cases local players simply don't have the money. In addition to having the necessary means, foreign investors also bring managerial experience, technology and access to foreign markets. 'Releasing the big' is going to take the sort of capital that only very large multinational companies and investment funds can bring to the table.
The principal benefactors, provided they are given enough regulatory leeway, will be private equity houses such as Texan company Loan Star and San Francisco's Newbridge, who will buy failing SOEs cheaply and try to turn them around. In addition to these financial investors there will also be a number of strategic investors who buy up SOEs for their sales networks, their infrastructure and their political connections.
One estimate puts State equities in publicly listed companies alone at RMB 6 trillion (US$725 billion). The government seems to have come to the conclusion that the risks and pain of change are necessary in order to head off far worse potential problems down the line.
In heading down the track of economic liberalization, China's government has found itself at the point where it has no real choice but to speed up the process of privatizing the state's assets and allow the 'invisible hand of the market' to take control of the economy. "We don't have a regulation setting a floor on pricing on SOE sales," said the Minister of the State Asset Supervision and Administration Commission Li Rongrong. "We leave that to the market."
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