Manager Insight: China’s long march toward capitalism

Many people think of Chinese state companies as its giant banks or oil companies. But state ownership is much more widespread than that. In all, says Chan, there are about 155,000 enterprises still owned by the central and local governments.

Over the past year, a series of reforms for state-owned enterprises (SOEs) — China’s brand of capitalism — were announced at both the central and local government levels. They’re aimed at boosting investment and improving profitability.

“SOE reforms will likely be a major catalyst,” says Chan, “in re-rating and driving up the valuations of the entire Chinese equity market.” Among the key breakthroughs in SOE reform, she adds, is the introduction of the mixed-ownership structure. This structure allows private enterprises to become major investors, offering diversification and improving efficiency and profitability. As well, an SOE can introduce foreign companies as partners.

Major industries in China, heavily monopolized by state capital, such as finance, oil and gas, telecommunications, railways and utilities, are likely to open the door to private capital, says Chan. This reform could provide sources of funding for the underdeveloped sectors, and improve their competitiveness. As well, SOEs can divest their non-profitable assets to the government in order to improve their overall profitability.

Chan says some of the SOEs that have gone through restructuring have performed strongly and most of them have delivered double-digit returns. “Basically we think the SOE reforms will drive up the valuations,” she says, “with more asset injections.”

Monetary easing is another investment theme that Chan thinks will draw investors’ attention this year. The People’s Bank of China surprised the market by cutting interest rates in late November for the first time since 2012. The central bank did so after a series of targeted stimulus measures failed to spur economic growth. If inflation is not a future concern, the bank will have more flexibility to cut the interest rate further to boost the economy.

The long-term lending rate in China is a steep 6%. Lowering interest rates, says Chan, is the most direct way to benefit small and medium-sized enterprises since rate relief will stimulate corporate investment. “We believe that further rate cuts should help the property sector and highly leveraged companies.”

As well, last September the People’s Bank of China and the China Banking Regulatory Commission relaxed mortgage policies and unveiled commercial lending policies to support financing for property developers. This is the first official loosening of housing policies by the central government since 2008. Second homes account for 30% to 40% of transactions in China, “so this is significant,” says Chan. With the lowering of rates and new reforms, Chan expects real estate will rebound.

In another financial development, the State Council has unveiled guidelines to address the debt risks of local governments. They include tighter regulation of new borrowing. If implemented strictly, says Chan, the guidelines should improve the financial stability of local governments and reduce risk in China’s financial system.

Active implementation of reforms should help boost key investor sentiment, says Chan, and prompt a potential re-rating of Chinese equities in the medium to long term. The high savings rate of 40% to 50% represents future growth potential if these savings can be unlocked. “They underspend in China,” says Chan. “A lot of it is still in property. So [the country] has to continue to drive the consumption with new innovation in China. The capital market is opening up and that will be a big change in the global market going forward.”