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Divestment: Lessons from China

July 02, 2004

After the momentum that the divestment process had gained under the aegis of the NDA government, the new United Progressive Alliance government has virtually halted the whole process.

The UPA government has actually emphasized that only the non-profitable enterprises would be privatized and the profitable and strategically important state assets would not be sold off. The most crucial reason attributed to the halt in the process is social.

There are fears that privatisation could lead to large-scale layoffs and no government at the Centre could afford that, especially if Left inclined parties support the government.

Another argument is, "Why privatise profit making companies in the first place?"

In this backdrop we take a look at the restructuring exercise carried out by the communist government in the People's Republic of China.

This study assumes importance, firstly due to the presence of a communist government at the helm of affairs and second due to the fact that public sector companies or State Owned Enterprises (SOEs) as they are called in China are a crucial building block of the Chinese society and restructuring of SOEs has been a sensitive issue in the country.

If one were to take a historical perspective of reforms in China, the market liberalisation process was started in the mid 1980s.

At the onset, internal restructuring was the most preferred methods to restructure the ailing and non-profitable SOEs. However, soon the emphasis shifted to the leasing out of SOEs, which could involve recruitment of managers from outside the company.

China also experimented with incorporation that eventually led to privatisation among the SOEs in the country. Incorporation opened up the possibility of a change in shareholding among SOEs.

Initially, shares were sold among the employees, but off late divestment to private entities have gathered ground.

Before we look at the consequences of restructuring on SOEs in China, we will try and understand the ways in which Chinese SOEs were restructured. Below are mentioned the most common restructuring methods employed by the Chinese government.

Public offering:  This maintained the state ownership on the company but diversified the shareholding among various entities.

Internal restructuring:  One of the most popular methods of restructuring, which maintained state ownership of assets.

This process could involve the breaking up of the company in to smaller units producing different products or setting up of a new entity to just take over owner ship of productive assets. Debt equity swap was also part of the internal restructuring process.

Bankruptcy and reorganisation:  Restructuring could also involve the bankrupt firms being dissolved.

Employee shareholding:  This has been one of the most popular forms of restructuring employed in China.

Being a communist mindset where collective holding of assets was always emphasised, this form of restructuring was popular since the employees were not threatened with retrenchment and hence this was the most socially acceptable restructuring exercise at that point of time.

Open sale:  This form of restructuring has become more popular in recent years. The firm is openly sold to insiders or outsiders, perhaps through auction.

This has been the most radical form of privatisation because it can involve the transfer of the firm to a single private owner or a management group.

Leases:  Under this form of restructuring, the assets of an SOE were leased out. The assets were leased out to legal entities independent of the government or ex-employees who formed their own companies.

Leasing is often adopted when the lessee has insufficient financial resources to buy the firm.

Joint ventures:  Formation of a joint venture or merger falls under this category of restructuring. This type of reform helped the company to obtain long-term access to capital and technology.

While these have been the ways in which restructuring has been carried out in China, off late, the emphasis has shifted to privatisation of assets wherever the situation permits.

However, the reality is that the communist government still controls the largest of the SOEs and it is still sometime away from carrying out much needed reforms in the same.

However, a financial system ridden with bad loans and lack of means of raising fresh capital has meant that SOE privatisation is becoming the imperative. Statistics also point in that direction.

In 1998, a quarter of the nearly 87,000 SOEs went through one or the other form of restructuring. At that time, between 60%-70% of these enterprises were partially or fully privatized.

In 2002, however, nearly 86% of industrial SOEs went through some form of restructuring while 70% of the same had been partially or fully privatised.

However, this does not indicate the state of the largest of the SOEs and, to that extent, this data can be misleading. The restructuring process of SOEs in China has been painful for the society but has been beneficial as far as performance of the SOEs are concerned.

Between 1995 and 2001 the number of state owned and state controlled enterprises fell from 118,000 to 47,000. Consequently total employment in the SOE segment fell by 36 million, which was nearly 15% of urban employment in 2001.

Due to the large-scale layoffs and further improvement in technology and higher capital inflows SOEs have become more productive. Studies also indicate that the highest improvement in productivity was among entities that have been privatised.

The objective of this article is not to highlight the success or the failures of the restructuring of SOEs in China, however it certainly is to highlight the fact that out central Asian neighbour is moving towards its objective of industrial reforms aggressively.

While it is true that industrial sector reforms are a larger imperative for an economy like China, due to its legacy of large and poorly performing state owned enterprises that contribute a very large part towards the overall industrial output of the country, the need for the same in the Indian context cannot be stressed enough.

It is safe to say that our Chinese counterparts have more experience as far as industrial reforms are concerned due to an early start to the economic reforms process in the country.

The need of the hour is to learn from the Chinese example and adopt a restructuring/privatisation model that best suits India. is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.

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