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China may intensify reform of indebted state enterprises after crucial Congress

Chinese President Xi Jinping could lay the groundwork for deeper reform of state-owned enterprises with debts running at about 115% of GDP in a five-yearly Communist Party Congress in which he aims to consolidate his power ahead of a second term, economists said.

SOE debt has ballooned as China continues to rely on credit-fueled investment to maintain growth, even as officials have increasingly recognized that longer-term economic stability requires a switch toward more domestic consumption. While authorities began trying to shake up SOEs in 2013, promoting mixed ownership, their debt burden contributed to downgrades of China's sovereign rating earlier this year by Moody's and S&P Global Ratings.

The 19th National Congress of the Communist Party of China, due to start Oct. 18 in Beijing, is expected to allow Xi to strengthen his already firm hold over the country's political apparatus, something which will be key to taking on the many vested interests entrenched in state enterprises. In addition to re-appointing him as party leader, the Congress will also elect a new generation of officials to serve under the president. Reforming the SOEs, many of which have become loss-making zombies kept alive by soft government loans or subsidies and contributing to industrial overcapacity, will be among their most daunting challenges. Dealing with the SOEs will also be crucial for improving the finances of the local governments with which they are deeply entwined.

The Chinese government issued guidelines for mixed-ownership of SOEs two years ago, saying that it planned to "achieve major reforms in key areas by 2020, when SOEs are expected to be more robust and influential and have greater ability to avoid risks" — but progress has been much slower than expected, said Xia Le, chief Asia economist at BBVA Research in Hong Kong.

"It is already 2017 now," Xia said. "The debt problem has become the biggest risk within China's economy ... And China's debt problem is basically the debt problem of SOEs, because private enterprises face hard constraints from the market while the SOEs do not."

Authorities are likely to expand their promotion of mixed ownership to more industries, prompt zombie companies to merge or sell out and withdraw implicit government bailout guarantees, Xia said.

Without much wider reform, China's economic growth will come under pressure, said Larry Hu, chief China economist at Macquarie Securities in Hong Kong.

"I think in the next five years, Xi will put more emphasis on these issues," he said.

Debts growing

SOEs' liabilities grew 11% during the first eight months of 2017 compared to the same period of last year, to more than 96 trillion yuan, although their assets also grew 11%, to 146 trillion yuan. Their debt-to-asset ratio edged down to 65.9% from 66.1% in full-year 2016, according to China's Ministry of Finance.

"There is no significant improvement of the debt-to-asset ratio," Zhou Hao, senior emerging markets economist for Asia at Commerzbank AG in Singapore, said in an interview. He expected to see more mergers between SOEs and more efforts to encourage bringing in private capital via mixed ownership.

"The government has been continuing to push SOE reform, but the process is slow," he said. "And there are calls from the market to accelerate the reform."

In August, China United Network Communications Ltd, or China Unicom, became the first company to move toward mixed ownership, raised about 77.91 billion yuan from private investors including tech giants Tencent Holdings Ltd. and Baidu Inc. as well as state-backed insurer China Life Insurance Co. Ltd.

Opportunities for reform have been bolstered by this year's strengthening economic growth, which accelerated to 6.9% in both the first and second quarters, up from 6.7% in full-year 2016. This helped SOEs boost revenues by 15.5% in the first eight months of 2017, while their profits grew 21.7% year over year.

"It looks like the economy will keep stabilized for quite some time," Zhou said. "Then why not act to contain the risks [posed by SOEs] while the economy is still good?

"There is still a question between stocks and flows. The question is how much can this year's revenue lower your accumulated debts?"

However, while economists expect to see a blueprint on further SOE reform from the Party Congress, its main focus is set to be political, and detailed five-year economic plans will not come out until the 3rd Plenum, which should be held in November 2018.

But President Xi himself has indicated that he is very aware of the urgency of tackling the problem, saying at the National Financial Work Conference in July that "deleveraging at the SOEs should be of the upmost importance," and adding that it was necessary to tackle zombie enterprises.

That event, also five-yearly, tends to set the tone for official policy for some time to come, said Qiu Zhicheng, strategist at ICBC International in Hong Kong.

S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.

As of Oct. 16, US$1 was equivalent to 6.59 Chinese yuan.