The Chinese government recently claimed that 98 major state-run industries have turned in the best industrial and financial performance in 2017 compared to the past five years. These companies, which have assets totaling $9 trillion, produced a remarkable profit of $218 billion, an increase of 15.2 percent in profit in 2017, more than double the rate of national economic growth.

Industry experts are closely examining the report card because China’s state sector represents nearly 60 percent of the country’s industrial economy. It controls areas like natural resources, steel, energy, heavy machinery, telecommunication, defense and infrastructure sectors, where the private sector has little or no role.

The government’s claim has caused some surprise because state-owned-enterprises (SOEs) have been widely blamed for corruption and sloth, with many economists saying they are a drag on the national economy.

The New York-based Center on Foreign Relations reported this month that profits of Chinese SOEs plunged 33 percent between 2011 and 2016, while that of the country’s private-sector enterprises rose 18 percent in the same period. However, the government and state-owned banks continued funding the state sector, which drew 80 percent of industrial financing, it said.

Lagging behind private sector

Analysts said the SOEs managed to come up with a better balance sheet in 2017, with tremendous assistance from the government. But there was no real improvement in their management capabilities and market competitiveness.

“The improvement in profitability does not mean they are more efficient or more productive and they still aren’t as profitable as private companies,” said Scott Kennedy, deputy director at the Freeman Chair in China Studies at the Center for Strategic & International Studies.

One reason for the improved profits report may be the closure of dozens of coal mines and steel mills and hundreds of factories as part of an effort to overcome problems of overcapacity and chronically loss-making units. This came at a social cost as reduction in coal capacity by 27 million tons and in steel capacity by 5.95 million tons resulted in layoffs of millions of workers in mines and factories.

Another part of the improvement was achieved by sales and swaps of piled up debt at 20-30 percent of their original value, leading to massive losses for banks and financial agencies that gave the loans. Nearly $158 billion was infused into these companies, banks, stock and property markets and other sources in 2017.

Mergers also eliminated competition as two or more rival companies came together to form a stronger monopoly.

 

Monopoly creation

“Those survivors, they can enjoy the monopoly, that is why they can enjoy higher profit margins because of the monopolies,” CEIBS professor of finance and accounting Oliver Rui said, adding, “Usually they were competitors, now they have become one company.”

 

The State-owned Assets Supervision and Administration Commission, which manages the 98 enterprises owned by the central government, claimed a major success in reducing their debt burden. Its chief accountant, Shen Ying, told a recent news conference that central SOEs are confident and able to repay their debt and prevent systemic risks in 2018.

“There was no issue of bond default by central SOEs in 2017,” she said. “We will continue to push SOE reforms, in particular in their operational mechanism, methods of building a modern enterprise system, regulatory measures of State-owned assets and the cultivation of entrepreneurship in 2018.”

State owned banks were ordered to swap their unpaid loans into equity making them part owners of their customers, the SOEs. A part of the debt was converted into equity.

Jason Lee, an expert with the China Market Research Group said he expected the government to continue with the drive to reduce SOE debt by getting banks, stock and property markets to inject funds in 2018. “My estimation is that it won’t be double (compared to 2017) but probably around like 700 billion or 800 billion (Yuan), he said. An important issue is whether the government is merely rewriting the account books or state run companies are going through a major improvement in their functioning.

 

“Yes, that’s artificially solving the problem,” Rui said. “So, in the long run you need improve your performance through either by reducing the cost, or through enhanced efficiency or by increasing your pricing powers, you could sell your products at a higher price.”

 

New normal

Improvement in market prices of goods produced by the SOEs also played a key role in their improved balance sheets.

 

“Producer prices in China are growing and those products come mainly from SOEs and that’s the primary source for the turnaround in SOE performance, balance sheet performance,” Kennedy said.

Kennedy said the ruling Communist Party is not interested in allowing the bureaucracy-run SOEs to perform freely in terms of market dynamics.

The Communist “Party is increasing its supervision and management of SOEs. So I think, what you are seeing is a cyclical change in their financial position because of the price environment but not changes in the structural, systemic issues that make state owned enterprises less competitive and profitable than  the private sector,” Kennedy said.

The government has been publicly saying that it is focusing on the quality of life in terms of better performance in welfare areas like education, health and poverty alleviation and GDP numbers are not as important any more. But privately, it is pushing the industry to achieve higher growth because it cannot afford a major economic slowdown, analysts said. In this respect, the government is forced to rely on the state sector a lot more than the private sector.

“The private sector stopped investing because there are so many critical uncertainties. So, the SOE is the major driving force behind the GDP growth,” Rui said.
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