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China’s Railways: A Cautionary Tale for SOE Reform

 
 

China’s railway system showcases the dilemma facing the government as it attempts to reform state-owned enterprises (SOEs), if not carry out liberalizing economic reforms at large.

Mixed-ownership reform aims for the public sector to tap into the capital and expertise of the private sector by mobilizing private investors to join SOEs. However, neither side of the deal seems keen on embracing it. Preferring the status quo, government officials are constantly calculating risks and making moves accordingly. Meanwhile, with their huge debts and assets, the size of SOEs leave few suitable matches in the private sector. As investment overseas is politicized, private investors have few alternatives. But without any say in SOEs’ corporate operations, private investors risk seeing their property nationalized later on.

After receiving criticism from China’s anti-corruption agency in June, the state monopoly China Railway Corp (CRC) seemed to be stepping up reform efforts. By the end of 2017, it had restructured all 18 regional bureaus into limited liability companies under its full control. With corporate bylaws dictating the roles of boards of directors, boards of supervisors, and professional managers, the restructuring will bring the subsidiaries into line with modern company practices. Having scheduled its own restructuring in 2018, CSR seems a step closer toward mixed-ownership reform.

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However, barriers to reform remain. To bring in private investors, CRC must, first of all, improve its profit prospects in the short term, while reorganizing its debts in the long term. Beyond the financial issues, CRC should reform its clearance and transport capacity dispatch system, while straightening out its public and commercial functions. For governance structures to be effective, CRC should respect the decisions of the boards and managers while restraining from interference.

After inheriting 2.66 trillion yuan ($428 billion) in debt from the disbanded Railway Ministry in 2013 and continuing borrowing to invest 800 billion yuan ($126 billion) a year through 2017, CRC had accumulated total liabilities of 4.83 trillion yuan ($760 billion) by September 2017. With assets of 74.5 trillion yuan, its total debt ratio stood at 64.76 percent. While making revenue of 724.9 billion yuan, CRC spent 410.9 billion yuan repaying principal with interest in the first three quarters of 2017. The fact is that CRC depends on government subsidies each year to turn its profit from negative to positive.

CRC has developed a few solutions to improve profitability: passenger fare hikes, land sales, and asset securitization. Two policies were released in 2017 to liberalize prices in other sectors with long-standing state monopolies: electricity, natural gas, and railways. In the name of market-based price reform, these policies pave the way for utility price hikes. After piloting fare increases and discounts for the southeastern coastal bullet trains in 2017, CRC is ready to raise passenger fares across the board.

One untapped resource of CRC is its land quota, which dwarfs any developer’s. According to the transport vice minister, among the 600,000 hectares land under CRC’s authority, a considerable amount (generally cited as 30,000 hectares) is eligible for development. A comprehensive land use scheme was thus designed for CRC to capture the land’s added value. Whether authorizing land to be developed by itself, leased, or sold to others, CRC will capitalize on the value of land originally allocated for railway construction.

Therefore, most CRC subsidiaries, after restructuring, have diversified their business line from transport to development. In fact, CRC launched 20 projects across China in August 2017, targeting high-profile deep-pocketed investors. However, with most of land parcels still undeveloped, resident relocation could be time-consuming and costly, and also dependent on government assistance. The complicated prospects for land sales or leases, involving shifting local urban plans, could overwhelm investors. Despite these challenges, Guangshen Railway company, a Hong Kong listed CRC subsidiary caught market attention in late December 2017 after disclosing a plan to monetize the usage rights of one land plot.

Another item on the CRC agenda is the securitization of qualified assets. The 13th five-year railway development plan, released in November 2017, called for asset securitization and public listing of high-speed railway enterprises with stable cash flows. Then CRC and Shenzhen Exchange signed an agreement in early January 2018 regarding CRC’s debt financing, asset securitization, and subsidiary listings. Eyeing private investors for bonds and assets sales, CRC intends to diversify away from institutional investors in the interbank market while increasing direct financing.

While fixing its balance sheet, CRC is actively pursuing investors in both the private sector, like Tencent and Alibaba, and the public sector, like China FAW Group Corporation (FAW). Seeing these investors as strategic partners, CRC intends to take advantage of their expertise in facial recognition technology, internet payment, logistics and the like to penetrate the market.

As a critical step toward price reform, CRC promised early this January to reform the centralized clearance system and transport capacity dispatch system. Under the current clearance system, revenues from local corporations are pooled together by CRC and then distributed back based on arbitrary calculation and opaque rules. With the centralized dispatch system, privately invested railways are subject to discrimination as priority is given to public funded ones. Controlling capacity dispatch is thus key to the property rights of private investors.

Behind the centralized clearance and dispatch system lies CRC’s status as a semi-public utility provider. Holding a state monopoly in the railway sector, CRC is expected to subsidize railway development in backwater regions through the profits gained from developed areas, and to subsidize public services with commercial operations. The centralized systems enable the cross-subsidizing. Pledging to draw clearer boundaries between itself and local subsidiaries as independent market players, CRC seems ready to take on public services and investment functions rather than burdening subsidiaries.

Even if these financial and technical issues could be fixed, CRC giving no say to outside investors could prove the most challenging problem. Despite the central government push for public-private partnership (PPP) in railway development, for example, CRC’s partners, from local authorities to private investors, find themselves voiceless in decision-making. With CRC making rules for project development while promoting its own interests, private investors could risk their investments being nationalized.

Xinling Wang works for China Policy, a Beijing-based policy consultancy and writes on China’s macroeconomic policy and politics.

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