September 2, 2014    4 minute read

Chinese Economic Reform: Taming the Industry Giants

   September 2, 2014    4 minute read

Chinese Economic Reform: Taming the Industry Giants

Although China has come a long way since opening up over 30 years ago in a dazzling transition towards a market economy, many domestic industry sectors are still dominated by large state-owned enterprises (SOEs), as the ruling communist party has been reluctant to decentralize control over the most essential organs of the Chinese economy. This uneven playing field has created many administrative monopolies and removed any incentive for these industry giants to reduce inefficiencies – but that is all set to change.

SOEs Lead Reform

It is no secret that the Chinese economy is in need of restructuring, as the country’s GDP growth continues to decline – China’s GDP growth was only 7.7% last year, little over half of the 2007 peak of 14.2%. While this is still an enviable figure for many countries around the world after the Great Recession, there is no doubt the Chinese economy is not achieving its full potential.

At a gathering of the ruling communist party late last year, the Chinese government made it clear to the world of its commitment to economic reform, with a priority focus on increasing the productivity and efficiency of SOEs. The leading initiative of SOE reform came to be known as “mixed ownership”, an idea synonymous with partial privatization – an unprecedented move to introduce private capital into the nation’s state-owned companies.

Citic Leads SOEs

The poster child of China’s SOE reform has to be Citic Group, a sprawling conglomerate with businesses in property, mining, energy, financial services and even a soccer team. Citic Group announced earlier this year of a plan to inject almost all of its assets into its subsidiary Citic Pacific. Listed in Hong Kong, Citic Pacific specializes in steel manufacturing and has mining operations in Western Australia. The deal was completed a few days ago, with Citic Pacific (now renamed Citic Ltd) purchasing US$37b worth of assets from its parent in exchange for cash and new shares. This restructuring will help streamline the previous sprawling structure of Citic Group, and provide the company with greater financing flexibilities.

The broader implication of this asset injection is that the businesses once part of an opaque state-owned firm are now subject to the transparency requirements of the Hong Kong market and accessible to the scrutiny of international investors. Of course, management decisions at the top are still made by the ruling communist party – after all, it is state-owned.

Future Outlook and Positioning

A report released by the Boston Consulting Group early this year cautions that mixed ownership structures cannot be a one size fits all solution to a diverse group of over 100,000 Chinese SOEs. Even within the mixed ownership structure, there is currently no agreement upon the proper contribution ratio between state assets and private capital. China needs to proceed slowly and carefully, and could learn from Western Europe, which underwent a similar process of privatizing national companies in the late 20th century. For instance, the privatization of British Rail in the 1990s was seen by many as a failure as it led to a decline in service quality and increase in safety incidents.

Nonetheless, other large Chinese SOEs will be looking to mirror the corporate restructuring model in Citic Ltd, as they are becoming interested in funding options beyond raising equity, such as private sales and pre-IPO investments. Oil group Sinopec is looking to a partial sale of its gas station business, while China National Building Material and Sinopharm are said to be next in line for mixed ownership reform. This trend looks set to improve corporate governance, reduce economic inefficiencies, and provide a more level playing field for smaller private companies to survive and thrive. Investment banks in the region will need to reposition themselves in a shifting landscape where the heydays of state IPOs are numbered and the private sector begin to prove a force to be reckoned with.

Get articles like this straight to your inbox each morning with our Breakfast Briefing. Sign up by clicking here!

Log in with your details


Forgot your details?

Create Account

Send this to a friend