SOE Dividends and Economic Rebalancing

One of the more interesting things to come out of the most recent Strategic and Economic Dialogue was a little more specificity on the topic of state-owned enterprises (SOEs) dividend reform. Given the intense disagreements within the Chinese government over this topic, moving forward with reforms is extremely difficult.

Chinese negotiators agreed to the following reform:

“To increase the number of SOEs that pay dividends as well as to increase the amount of dividends actually paid.  China will further encourage listed SOEs—which include China’s largest and most profitable SOEs—to increase the portion of profits they pay out in dividends so as to be in line with market levels.  SOE profits, as a share of China’s GDP, rose from 1.7 percent in 2001 to a peak of 3.7 percent in 2007, just prior to the global financial crisis, contributing to China’s imbalanced growth pattern.  Unlocking the profits maintained in the corporate sector will help boost China’s domestic consumption, creating new opportunities for US producers.”

Why is China’s SOE dividend policy important? SOEs were exempted from paying dividends through much of the 1990s and 2000s, partly to let them repair their balance sheets but also because of resistance from politically influential SOE managers. Not only did not paying dividends give these firms an advantage over current and potential competitors by keeping their cost of capital low, but it also denied the government revenue that could have been spent on pensions, education, and other social services.

This changed in 2007 when the State Council mandated central SOEs to begin paying dividends, 10 percent in highly profitable industries, 5 percent in the industries where SOEs were less profitable, and 0 percent for protected firms like military armaments manufacturers. This past year rates were increased by 5 percent across the board to 15, 10, and 5 percent.

While this was a step in the right direction, it is still well below what SOEs should be paying. The World Bank did a good job pointing out how far Chinese SOEs were still from normal dividend payout ratios. The average dividend payout for mature and established industrial firms in the United States is 50 to 60 percent. The average dividend for SOEs in five developed economies was 33 percent. Chinese SOEs that are listed in Hong Kong pay an average dividend of 23 percent. So even the top rate of 15 percent set by the State Council is still quite a bit below what Chinese SOEs themselves pay to shareholders in Hong Kong.

By any standard, the dividend requirement for Chinese SOEs is quite low. What’s worse though is that these funds are mostly not making their way into the general budget to pay for public expenditures. After a fight between the Ministry of Finance (Mof) and the State-Owned Assets Supervision and Administration Commission (SASAC) over who would control central SOE dividends, it was decided that MoF would collect dividends and put them into a fund called the State Capital Management Budget.

One thing to note is that the Chinese state-owned commercial banks are outliers on the dividends issue. They are not part of the State Capital Management Budget and pay a much higher rate directly to the Ministry of Finance (35 to 40 percent) in order to foot the bill for the sovereign wealth fund, China Investment Corporation.

The funds in the State Capital Management Budget were mandated by the State Council to be used in the general budget or for other public expenditures. This, however, has not generally been the case.

SCMB Dividend Collections:

While the total State Capital Management Budget (dividends, carry over funds, and assets sales) grew to 87.5 billion renminbi in 2012 this year (Chinese language), as in previous years SASAC has managed to recycle most of these funds back to the SOES in the form of restructuring support, financing mergers and acquisitions, environmental and technology investment, supporting overseas investments, and reducing pensions costs. In fact in 2012 as much as 90 percent of the funds collected flowed right back to the SOEs.

Thus SOE reform through increased dividends is a little bit of a farce. Even if SOEs are forced to pay higher dividends, if the money is just being recycled back to them or other SOEs though the State Capital Management Budget it doesn’t represent much of a reform. As Nick Lardy points out in Sustaining China’s Economic Growth, unless these funds are channeled to social programs rather than being shuffled around by SASAC within its family of firms, increased dividends will do little to promote economic rebalancing.

It’s a positive sign that the conversation has turned back to SOE reform. But until the problem is addressed in the right way, there isn’t much hope for real reform. The profits of SOEs should be returned to the state and used for the benefit of the public, who are ultimately the owners of these enterprises.