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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 slower.
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 assets.
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 policy burdens.
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 placements.
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 socialist system.
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.