Talking about Chinese massive debt and its opaque structure, some analysts attempt to provide a sign of relief by pointing to the fact that the government has substantial holdings in SOE assets. The implicit argument goes, the state government can sell the SOE assets, whose value are way bigger than the value of the current bank debt, to pay the loss in the loans to local governments and relevant financing vehicles, and hence save the banks. I used to believe so on its face value, but now I have to rectify my views on that.
Such argument is probably formed by looking at the “aggregate” balance sheet of the government – if you add up the value of state holdings in SOEs, the figure, no matter how inaccurate it may be, is certainly more than enough to cover the loss that the government has to assume from the bad debt in the worst economic scenario. The question is, is it correct to “aggregate” such balance sheet? Besides, is there any contagion risk in selling the SOE assets?
- Selling the holdings in listed SOEs. Admittedly the massive SOE floatation between 2003 and 2007 and the relevant reform – compensating private investors for the floating of SOE shares- have opened up another source of SOE financing and hence reduced the burden of banks. Private investors were happy for the compensation and pleased to see the SOE to release more information to the market. However, one has to be aware that the government still owns a major chunk (from 51% to more than 70%) of the shares of the listed SOEs, which means the private investors (e.g. funds and insurance companies) remain the minority shareholders. What is interesting and fascinating in the Chinese market is that, the A share price -formed by the trading of these minority shareholders- doesn’t appear to have discount compared to the price without government holdings otherwise. Or put it the other way: there should be some discount on the price paid by the minority shareholders as a) they can’t influence the firms’ decision making; and b) the major shareholder (reading the government) can one day sell a significant amount of the shares back to the market without losing any control of the firm. So what happens? My wild guess is that people tend to see the government being “wealthy” being superior taxing power at hand and hence sees little risk of government selling SOE asset any time sooner. The fact that fund managers are relatively young in China and usually have short history of managing a single fund also contribute to the short-termism of the potential asset buyers – let’s play as long as the music doesn’t stop. However, if what is perceived as “little risk” turns out the risk, contagion is due to happen and the theoretically-assumed price discount will appear in the market, spreading across a wide range of stocks.
- Selling unlisted SOE assets. Apparently it is even less feasible than option one for three reasons: a) for industries deemed to be sensitive (and the list of “sensitive” industries is usually longer in China than in most other countries), it is never considered to be sold even a small part to private investors. b) The SOEs remaining unlisted are usually harder to be valued by the market than their floated peers, one reasoning being their business model is very much reliant on the monopolistic revenue guaranteed by the government or the soft budget constraint on the cost side. c) The current stakeholders in many SOEs don’t favor shares being sold to private hands, as the selling will inevitably erode the substantial benefit they currently enjoy under government guarantee, soft budget constraint and opaque pay structure, as more relevant information becomes public and subject to scrutiny. And more importantly, it is hard for me to see the stakeholders in the “profitable” SOEs will be pleased to compensate the loss made by other local governments.
- I doubt the selling of listed and unlisted SOE assets will truly achieve the improvement in economic efficiency that ultimately benefits the whole society, as the selling is far away from privatization that puts the business in the private hands to run. Without improvement in efficiency, the selling is merely a wealth transfer from private investors to the government and then to the banks which are majorly owned by the government (again). By the way, who else are due to benefit from the selling process? The investment banks and advisors who charge a fat fee on the transaction.