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Are China’s state giants reformable?

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AMONG investors it is fashionable to say that China’s state-owned enterprises (SOEs) do not matter much any more and that entrepreneurs now power the world’s second-largest economy. But China’s SOEs are still hard to avoid. They account for 40% of its stockmarket and a third of its investment, and they dominate heavy industry. On the global stage, SOEs’ appetites sway commodity prices and many are expanding abroad.

These empires of men and machines account for 45 cents of every dollar of debt in China, so their health determines whether the country’s financial system will escape a crisis or blow up. And SOEs have become a loaded gun on the negotiating table between China and America. Treasury officials argue that China has broken the promises it made upon joining the World Trade Organisation in 2001 about further liberalising its economy. According to one negotiator, it is “abusing the system” by subsidising SOEs which in turn rig markets, dump cheap exports abroad and deter foreign firms from winning market share in China.

Schumpeter is sympathetic to the complaints, but to hear the other side, he met the State-owned Assets Supervision and Administration Commission (SASAC), an agency at the heart of China’s industrial deep state. It controls 100-odd of the largest SOEs. The overall impression is of an organisation that wants to modernise state firms, but which is struggling to reconcile goals that appear to be fundamentally contradictory.

Forty years ago most industries were government departments without proper book-keeping or independent regulators. Today 63% of SASAC’s portfolio is listed on the stockmarket. Reform was intended to make firms more efficient and responsive to market signals. In the 2000s it was possible to dream that China might eventually relinquish control of its SOEs.

But after the subprime crisis in 2008 things went in the other direction. China’s stimulus programme led SOEs to expand and run up debts. Since Xi Jinping became China’s leader in 2012, he has bossed about both SOEs and private firms. On February 22nd the state seized control of Anbang, a private insurer that is accused of fraud (see article). Some reckon the Chinese government may have indirectly helped fund Geely’s purchase of a 9.7% stake in Daimler, which was announced on February 24th. At least 30 SOEs listed in Hong Kong have changed their constitutions since 2016, to give the Communist Party a formal role in their governance. The top 60 listed SOEs, excluding banks, collectively trade at a lowly 1.2 times capital employed—suggesting investors are unsure if they are run for politicians or shareholders.

While SASAC is not explicit about it, it has three, conflicting, objectives: to boost profits and cut debts; to persuade foreigners that SOEs have more autonomy, and to cement the party’s muscular role. According to SASAC, the Party wants to guide the conduct of SOE bosses but not micromanage. SASAC itself does not want to be responsible for firms’ results, but wants to set the boundaries of strategy. So if PetroChina, an energy giant, bought an oilfield, for example, SASAC says it would not intervene, but if it tried to buy a goldfield it would. Likewise, SASAC caps the salaries of SOEs’ top brass whereas it is relaxed about underlings’ pay.

One option would be to copy Singapore. It has Temasek, an independent firm with holdings in “strategic” listed firms. Temasek is expected to maximise long-term returns and rarely meddles. SASAC replies that China’s SOEs are too big for this structure to work well. The top 60, excluding banks, have a market value of $1.5trn, seven times that of Temasek’s holdings. SASAC argues that a Chinese Temasek, huge and with autonomy, would have too much power (SASAC is also enormous but part of the government and subservient to it).

Is there any way to square the circle? SASAC’s experiments fall into two buckets. In the first are less-than-convincing initiatives, such as changing SOEs’ culture so that they allocate resources more like private firms. That is impossible to verify. It has promoted “mixed ownership” in which SOEs raise private capital. Last year China Unicom, a telecoms firm, raised $12bn from a consortium that included Tencent and Alibaba. But Unicom, like most SOEs, already had private minority investors so it is not clear what has really changed. SASAC has also pushed for mega-mergers, such as that between Shenhua Group, a coal firm, and China Guodian Group, a power company. It is likely that such combinations cut costs, improve profits and lower debt. But they might also create a new class of monster SOEs with even more clout.

In the other bucket are SASAC ideas that could make some difference. It says that in “competitive” industries (including coal, steel, pharmaceuticals and construction) it will let its stake drop well below 50%. That could signal a willingness on the part of the state to concede some ground. And SASAC wants SOEs to find ways to expand abroad while containing political tensions. An example is ChemChina, which in 2016 bought Syngenta, a Swiss chemicals firm, for $46bn. The deal was controversial and in order to convince customers and the Swiss that Syngenta is not run from the party’s leadership compound, Zhongnanhai, ChemChina gave its target an unusual degree of autonomy—it will keep its headquarters in Basel and is to have independent directors.

Show them the money

SASAC has a hard task to sway critics. At the very least it should press SOEs to boost returns as a way of showing that they are not underpricing products or being subsidised. Total operating profits for the top 60 listed SOEs (excluding banks) have risen by 17% since 2016, according to Bloomberg data, and leverage has stabilised. That is progress, yet returns on capital are still a dismal 5%, half the level expected of private firms. Mr Xi clearly sees business as an arm of state power. SASAC will therefore struggle to show the world that SOEs are free from interference. But demonstrating that they make commercial rates of return would help.

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Japan still has great influence on global financial markets

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IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.

“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.

This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.

One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).

But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.

Tokyo storm warning

These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.

Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.

What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.

Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.

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