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State-owned enterprises will no longer get a free ride as the Chinese Government steps up reforms and more profits will go to public benefits.

 

A State Council meeting on May 30, presided over by Premier Wen Jiabao, decided to carry out a pilot project to compile budgets for the management of state capital for enterprises owned by the Central Government. This decision will end a 12-year period during which 157 central state-owned enterprises (SOEs) led by Sinopec paid the government only taxes and no dividends.

 

The new operating budget system refers to a plan that would allow the government, as the controlling stockholder of SOEs, to recoup an appropriate portion of their huge profits and use the dividends to address issues concerning the daily life of common people.

 

The new budget system consists of factors concerning income and spending. A major source of income is derived from the dividends of exclusively state-owned enterprises with diversified operations. Another possible source of income would be from the sale of stocks of less vital enterprises. As for spending, the government will increase investment in SOEs vital to the lifeline of the economy, and write off the costs of bankruptcy and liquidation of other SOEs.

 

The detailed plan has yet to be introduced, but a proposal drafted by the Ministry of Finance about sharing dividends from SOEs has been submitted to the State Council for approval. According to the proposal, the collection of SOE dividends will be at a rate far less than the average dividend rate on the securities market.

 

Li Rongrong, Director of the State-Owned Assets Supervision and Administra- tion Commission (SASAC) who takes care of the 157 central SOEs, said they wouldn't design one solution for all the SOEs and would adopt different rates to reflect the variety of SOEs.

 

The budget plan will cover central SOEs supervised by the SASAC this year. Tobacco enterprises will be incorporated next year, and railway enterprises will not be covered for the time being.

 

Zero dividend

 

State-owned enterprises in Western countries all pay dividends to their respective central governments despite differences existing in profit appropriations. SOEs in China, however, are privileged and pay nothing in return for state investment. The Central Government offers these enterprises policy and budgetary supports even when it suffers from fiscal difficulties. This practice can be traced back to the 1994 tax reform that abolished the dual-tax system and adopted a single unified tax system for domestic and foreign companies. The goal of this reform was to promote market-oriented economic development.

 

After the tax reform, China gave up the dividends from SOEs, mainly because of a major change in funding SOEs. The SOEs used to rely on budgetary allocations for fixed assets investment and then had to secure loans from banks to invest in fixed assets and repay the loans and interest themselves. Besides this, SOEs shouldered part of the government's social security function for its employees. In the 13 years since the tax reform, the government has not asked SOEs for a portion of their profits.

 

With the establishment and improvement of the social security system and the deepening reform of SOEs, SOEs gradually turned the responsibility of providing social security benefits for employees back to the government, thus gaining vigor and strength in pursuing further development.

 

Statistics from the Ministry of Finance show that SOEs in China reaped total profits of 1.1 trillion yuan in 2006, of which over 770 billion yuan was attributed to central SOEs. According to the ministry, central SOEs will harvest over 800 billion yuan of profits this year, and the total amount will exceed 1.2 trillion yuan when taking account of local SOEs.

 

A majority of profits, however, are in the hands of central SOEs enjoying monopoly privileges. Of them, three oil giants, PetroChina, Sinopec and China National Offshore Oil Corp., accounted for half of the total profits of all central SOEs, with combined sales revenue in 2006 surpassing 2 trillion yuan. The two root causes for their skyrocketing profits were "the soaring prices of energy resources as well as their monopoly of the market," analyzed Liu Jipeng, professor with the Capital University of Economics and Business.

 

A disgruntled public has complained that such huge profits have not been submitted to the government for public benefits. In addition, central budgetary expenditures have kept subsidizing these enterprises in recent years. Sinopec, for instance, received 10 billion yuan in budgetary allocations when the international price of crude oil kept rising in 2005 and an additional 5.2 billion yuan from the Central Government at the end of 2006.

 

In fact, losses in oil refinery business didn't affect Sinopec's overall profits due to its huge profitability potential in crude oil exploration. Statistics from Sinopec show it still achieved a profit growth of 30 percent in 2006, bringing its total profits to 53.91 billion yuan, despite a loss of 25.3 billion yuan in the oil refinery business.

 

At the same time, huge profits remain within these monopoly sectors, enlarging the rich-poor divide in China. Bu Zhengfa, Vice Minister of Labor and Social Security, disclosed in May 2006 that the average salary for employees in monopoly sectors including electricity, telecommunications, finance, insurance and tobacco is two or three times that of employees in other sectors. The gap is likely even wider due to unreported "gray" income and generous welfare benefits employees in these sectors receive.

 

Blind investment and expansion

 

"Aside from these unfair allocations, another direct problem of the large profits resting in the hands of SOEs is blind investment," said Luo Jiangang, a researcher with the Ministry of Finance.

SOEs usually face a hotbed of risks as they have never worried about investments and have less pressure for financing compared to other enterprises in China, according to Yin Zhongyu, Executive Director of the Shanghai Longrange M&A Consulting Co. Ltd.

 

"International convention tells us that a large-scale merger and acquisition project usually takes one to three years to complete, with the investigation stage alone taking at least half a year," said Yin. "Some central SOEs expanded rapidly by frequent M&A moves in quite short periods. The mounting risks behind this irrational practice have given rise to public misgivings. "

 

China National Chemical Corp. (ChemChina) is a typical example. The corporation snowballed through acquisition of over 20 domestic companies in two years. Yet, size is not everything. They ended up lapsing into a situation that didn't match their acquisition goals.

 

Yin cited the case of acquiring Qingdao Yellow Sea Rubber Group for example.

 

"Qingdao Yellow Sea Rubber Group, with heavy debts, possessed zero net assets though boasting total assets of 6.5 billion yuan, while its major acquirer, China Vehicle Group as a part of ChemChina, had only 3.5 billion yuan of total assets and 900 million yuan of net assets," said Yin. "It was a case of a pony pulling a large cart, jeopardizing the accounting liquidity".

 

"Currently, profits of SOEs are soaring, average salaries in monopoly sectors are growing, and centrally controlled SOEs spend blindly," said Liu. "All these factors have impaired the state's efforts to prevent economic overheating. Appropriate SOE dividend collection will help to ease the pressure."

 

He also pointed out that the absence of an operating budget system of state capital accounted for the situation that allowed failing enterprises no exit, and made it difficult for the government to protect SOEs it intended to support. After the new system is established, unused resources will be transferred to other enterprises, optimizing the structure of the state-owned economy and enhancing the competitiveness of SOEs.

 

Public benefits

 

When the dividend collection plan is in place, the total net profits of SOEs should top 1 trillion yuan this year if centrally controlled SOEs were to achieve a total after-tax profit of more than 700 billion yuan in 2007, coupled with the 300 billion yuan in net profits of SOEs owned by local governments. Based on these predictions, "it is no problem for the state to get 70 billion yuan in dividends," if the state collects an average of 10 percent of all net profits, estimated Cheng Wei, Secretary of Macro-Strategy of the SASAC Research Center.

 

Then the question follows: How to better use the fattened dividends? Some analysts think they should be used to improve education and medicare conditions. Others believe the government should learn from developed countries to establish special per-capita energy and transport allowances.

 

Li Rongrong with the SASAC expressed the opinion that dividends should be used for the reform and restructuring of SOEs in the first two years and later to address the weak points of these enterprises such as the R&D ability.

 

Li Shuguang, professor with China University of Politics and Law, agreed with Li Rongrong and said, "The SOE dividends should be used to pay the reform costs of SOEs, reinvest in them and improve the social security system as a whole."

 

The utmost advantage of an operating budget system of state capital, in the eyes of Louis Kuijs, William Mako and Zhang Chunlin, economists from the World Bank China Office, would be to increase the state's income and the amount of spending in the public budget. They estimated the state could increase spending on education and medicare by 80 percent if they collect 50 percent of SOE net profits as dividends and invest all the money into the two fields.

 

This view is echoed by many Chinese scholars. Song Guoqing, professor with the China Center for Economics Research at Peking University, said the most important is to ensure that the money goes to individuals through tax deductions and other measures.

 

(Beijing Review July 5, 2007)