China: Reforms to Increase Private Equity in State-Owned Enterprises
To combat increasing levels of debt and inefficiency in its state sector, the Chinese government is attempting to bring private sector investment and management into state-owned enterprises (SOEs).
In November 2017, the National Development and Reform Commission (NDRC), China’s main economic planning agency, announced a third round of pilot mixed-ownership reforms, bringing the total number of SOEs participating in the program to 50.
Rather than signaling an increased effort toward privatizing key sectors of the economy, mixed-ownership reforms seek to make SOE operations more efficient and less reliant on government support while strengthening the government’s central role in the economy, according to a recent report from the US-China Economic Security Commission.
SOEs remain an important part of China’s economy, but they are struggling due to inefficient operations and increasing debt. According to the Beijing-based financial research firm Gavekal Dragonomics, all SOEs account for more than one-third of total investment and receive nearly 30 percent of all bank loans in China, yet they generate less than 10 percent of China’s total gross domestic product.
Faced with years of declining returns, SOEs have become increasingly reliant on loans from state banks: from 2008 to 2015, SOEs increased their loans relative to assets from 53 percent to 64 percent—nearing the United States’ 70 percent debt-to-asset ratio before the 2008-2009 financial crisis—while private companies’ loans relative to assets declined over the same period.
In 2014, the Chinese government announced its first plans for mixed-ownership reforms, which would bring private sector investment and management into local and central SOEs. Under the program guidelines, each participating company chooses a unit of the business, which then sells around a 30 to 45 percent stake to the private sector. According to China’s Caixin news service, the funds raised through the sale typically total more than $1 billion for central SOEs. These funds are then reinvested in new projects between the SOE and its new private investors.
After the sale, the central government remains the firm’s largest shareholder, generally retaining at least 50 percent ownership and continuing to dictate the company’s management and strategic planning.
In the first two rounds, China’s State Council selected 19 SOEs (primarily central SOEs)—in industries ranging from electrical services to civil aviation—to proceed with the pilot reforms. Notable firms that have participated in the pilot program to date include China Eastern Air Holding Company and China Southern Power Grid.
The third round of reforms will involve 31 additional SOEs, including both centrally and locally administered firms that have applied for the program and been approved by the State Council.
In the first half of 2018, the NDRC plans to establish a $15 billion fund (made up of contributions from large central SOEs, other state investors, and private capital) to assist with implementing further mixed-ownership reforms. Several smaller funds on both the national and local levels have also been created to assist with SOE restructuring, including the Beijing China Structural Mixed Ownership Reform Investment Fund, which seeks to facilitate local mixed-ownership reforms in Shenzhen, Shanghai, and Xi’an.
Although mixed-ownership reforms seek to increase private capital in public firms, Chinese policymakers have stated the reforms will not lead to the full privatization of state assets. Instead, these deals are structured primarily as capital injections for indebted SOEs while allowing the government to maintain its controlling stake in the firm.