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July 17 (The following statement was released by the rating agency)
Fitch Ratings says the recent announcement
by the Chinese regulator reflects progress on efforts to reform China's
state-owned entities (SOE). China's State-owned Assets Supervision and
Administration Commission of the State Council (SASAC) has proposed to
establish state capital investment companies (SCICs), a move which Fitch
believes may potentially impact the credit profiles of the SOEs undertaking
this policy role, as well as those SOEs whose state ownership will be
transferred to the SCICs. The agency also expects the SASAC to give priority to
SOEs in less strategic market-oriented sectors in promoting hybrid ownership,
while reforms for SOEs in strategic sectors are likely to be comparatively
The SASAC has selected the State Development & Investment Corporation (SDIC) and
China National Cereals, Oils and Foodstuffs Corporation (COFCO) to become state
capital investment companies - in the style of Singapore-based Temasek Holdings.
Under a pilot scheme, SDIC and COFCO will hold ownership rights of state-owned
entities (SOEs) on behalf of SASAC. This is a step forward towards the
separation of SASAC's dual roles as a shareholder and regulator of state-owned
Both SDIC and COFCO are large conglomerates running a combination of
competitive, market-oriented operations, as well as strategic, policy-oriented
functions. We expect their credit profiles to evolve as they undertake this new
policy role, depending on which SOEs will be transferred to SDIC and COFCO and
how they will acquire these SOEs.
Fitch also expects potential changes to the credit profiles of the SOEs whose
state ownership will be transferred to SDIC and COFCO, especially their linkages
with their new parent companies and with SASAC. SASAC will need to address the
role of many SOEs' existing holding companies, i.e. the 100% state-owned group
corporations that form the extra layer between SASAC and operating subsidiaries.
These state-owned group corporations are typically less commercialised and have
retained some lower-quality assets, surplus labour force, legacy debt, and other
SASAC has also appointed China National Building Material Group Corporation
(CNBM) and China National Pharmaceutical Group Corporation (Sinopharm) to pursue
hybrid ownership structures. CNBM operates in the fully liberated, highly
fragmented, and competitive basic materials sector, while Sinopharm's core
businesses of distribution, logistics, retail, scientific research and
manufacture of healthcare products are also largely market-oriented.
Although the post-Third Plenum reform proposals have pledged to introduce
private capital into all sectors, we think it is easier for SASAC to push
forward reform in less strategic, market-oriented sectors where SOEs tend to be
less represented and vested interests are less prominent. Both CNBM and
Sinopharm have already gone through several phases of industry consolidation and
corporate reorganisations throughout their history and many of their
subsidiaries are already privatised via public listings and/or private equity
Reform is also more likely for SOEs in market-oriented sectors facing structural
challenges such as softening demand and persistent capacity surpluses.
Prevailing supply/demand imbalances have resulted in margin erosions and
weakening operating cash flow generation for many SOEs. Coupled with heavy
debt-funded capital expenditures in the last few years, those SOEs have seen
wide free cash flow deficits and rising financial leverage. As a result, reform
measures including privatisations and asset sales could bring quick economic
benefits for them with the proceeds used to pay down debt.
In contrast, SOEs typically enjoy strong or even dominant market positions in
sectors of high strategic importance to national security, economic growth, and
social stability. Reforms in the strategic sectors are likely to be hindered not
only by powerful vested interests that have gained significant political and
economic influence through the years, but also due to concerns that breaking up
state monopolies could result in state asset losses or de-stabilize the
In its latest announcement, SASAC also allowed CNBM and Sinopharm along with
Xinxing Cathay International Group, and China Energy Conservation and
Environmental Protection Group to let their Board of Directors exercise the
rights to senior management hiring, performance reviews, and compensation
management. In addition, SASAC will station disciplinary teams at two or three
SOEs to administer the government's anti-graft efforts.
For more information regarding Fitch's view on the latest round of SOE reform,
please refer to the special report "China State-owned Enterprises - On a Bumpy
Path Towards Market Reform" published on 6 June 2014.