China’s President Xi Jinping wants to regain the private sector’s confidence even as he squeezes it more tightly. Aligning private investment with state priorities could grease the bureaucratic skids for some companies, but more official meddling in board rooms is unlikely to produce good business decisions. Opaque party politics will confuse outside investors and blur the line between some state and private companies.
The private sector creates most of China’s jobs, generates the bulk of its GDP and is by far the most efficient user of labor and capital. China’s economic growth miracle has occurred largely thanks to the ability of private companies to generate profit despite a shaky legal environment, entrenched official corruption and constant regulatory meddling. Yet despite the country’s recent economic recovery, private investment is in a prolonged funk. It notched up 6.4 percent growth in the year to August, in part due to a rebound in manufacturing and local government investment. That’s better than the dismal performance of last year, but still well off the 15 percent-plus growth rates of recent years. The softness could in turn sap long-term growth: the IMF reckons private firms generate around 7-8 percentage points higher return on assets than their state-owned peers, but investment by the latter has far outpaced the former in the last two years.
Officials recognize the risk. Despite the broader economic rally underway, private investment has never truly recovered from the downturn in late 2015. This year’s revival depended in no small part on fiscal stimulus, a real estate rally and high commodity prices, all of which disproportionately benefit the state-owned enterprises that dominate China’s heavy industry. If those areas come under pressure, private capital will be vital to maintain high growth. Thus the state is trying to re-inspire entrepreneurs with rhetorical blandishments. On Sept. 25, officials unveiled guidance to foster “the entrepreneurial spirit”; some think boosting the private sector might even feature as a theme at the 19th Party Congress next week.
Mixed messages
The government has already put some money where its mouth is. The central bank said it would slash reserve requirements for banks in order to boost credit to smaller companies, which some analysts estimate could add up to $150 billion of long-term liquidity. Premier Li Keqiang continues his drive to reduce fees, taxes and red tape that cut into profit margins. New areas of the economy have slowly and fitfully been opened to private investors. Partly as a result, China advanced to 78th place in the World Bank’s “ease of doing business” index this year, up from 93 a decade ago.
The trouble is, nearly everything else Xi is doing suggests a deep-rooted distrust of powerful private firms. Even as officials talk of getting SOEs to withdraw from non-strategic industries – the state still dominates beer and cigarette sectors – the government is inserting itself into businesses by other means. Officials have noticeably expanded their influence at large private firms, including multinationals, by inserting party committees into their governance structures. Executives sometimes feel compelled to participate in political projects such as the Xiong’an New Area and the Belt and Road Initiative. Bureaucrats have also rolled out “guidance funds” to buy stakes in priority industries and promote “mixed ownership” investments into state companies, occasionally using private capital. In certain cases that has translated into technology giants like Alibaba being more or less dragged into partnerships with state-owned firms like China Unicom.
It may yet go further. On Thursday the Wall Street Journal quoted sources saying internet regulators were discussing taking 1 percent stakes in Tencent, Weibo and Youku Tudou. The government is cracking down on overseas investments by private firms that it deems ill-advised. Deals by conglomerates including Dalian Wanda, HNA, the Fosun Group and Anbang Insurance have come in for particular scrutiny. Even the “entrepreneurial spirit” policy guidance contained a bizarre call for greater party discipline. The next generation of outbound investors could look more like CEFC China Energy, a mysterious privately held firm with policy bank backing that is currently executing a $9.1 billion strategic investment in Russia’s Rosneft.
Investors should expect this divergence to continue into Xi’s second term. On paper, firms will likely face somewhat less red tape and doing business will become genuinely easier. Behind the scenes, however, the invisible hand of the party may extend its grip at the largest companies. Party politics, even at their most benign, are a distraction at best for senior management. But if officials continue to take a more active role in corporate decision-making, the famously efficient Chinese private sector could start looking a lot more like its wasteful state-owned counterpart.