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Profits at China’s state-owned enterprises poised to plunge further

Profits at China’s state-owned enterprises poised to plunge further

Originally published at the South China Morning Post on December 1, 2015.

China’s bloated state-owned enterprises, faced with crippling debts and soaring financial costs, are poised to see the worst profit plunge in three years.

And their earnings are expected to decline even further next year despite Beijing’s efforts to restructure the sector.

SOE profits fell by 9.8 per cent year on year to 1.88 trillion yuan (HK$2.27 trillion) in the first 10 months of this year, down from $2.08 trillion yuan in the same period last year, according to analysts from investment firm Reorient. Those in industries such as steel, coal and non-ferrous smelting are seeing losses rise rapidly, and analysts expect the trend to continue as government reforms to consolidate the sector fail to produce results in the short run.

“It will take a long time – you will not see the results in the near term,” said Ben Kwong Man-bun, executive director and head of research of KGI Asia. “You have to tackle this problem, otherwise it will eat up a lot of resources. It’s just like cancer – you have to kill [the problem].”

State sector profits plunged 21.5 per cent year on year in February to about 256 billion yuan, in what was the biggest year-on-year fall since 2009.

Louis Tse Ming-kwong, director of VC Brokerage, said energy sectors like coal mining were suffering because of China’s economic slowdown, excess supply, lack of demand and the shift away from traditional industries in the “old economy” towards the tertiary sector.

“If they continue to revise downward the GDP, it means the demand for those industries are declining,” Tse said. “The worst is not over yet.”

In recent months, the central government has announced plans to overhaul the state sector by introducing private investment and mixed ownership, hiring professional managers and establishing a pay system that is more market-based and malleable, among other reforms. Yet analysts say that in the short term, such measures will have a limited effect in cushioning deteriorating profits.

Kwong said the government’s efforts to increase the competitiveness of SOEs through mergers or introducing private capital could improve the sector’s efficiency and decrease the chances of resource duplication. The manufacturing sector also suffered from overcapacity and stockpiling, and shares were expected to continue to decline as the market continued to slow, he added.

The central government recently set a 6.5 per cent floor for annual economic growth from 2016 to 2020, below the annual target of 8 per cent in the preceding five years.

“The main purpose [for SOEs] is to absorb the employment within the country,” Tse said, adding that the same issue applied for Chinese SOEs abroad, for example in Russia. “Even though they have a deficit they still keep the operation going.”

He said cutting interest rates would lower SOEs’ financial costs but would not help stimulate demand, which was a crucial missing factor.

The People’s Bank of China cut one-year interest rates last month for the sixth time since November 2014, lowering one-year rates by 25 basis points and bringing the benchmark to its lowest level in more than two decades. The central bank also lowered the reserve requirement ratio for banks once more in an attempt to stimulate growth.

Lars Peter Hansen, a Nobel Prize-winning economist from the University of Chicago’s Becker Friedman Institute for Research in Economics, argues that the government should focus on opening up investment opportunities for foreign investors in private enterprises. The strongest productivity across the mainland came from private enterprises rather than the state sector, he said.

“External investment outside the state-owned-enterprise sector is very important,” Hansen said. “My hope going forward is that there are more and more efforts to allow [investments] into these activities.”

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