China's plan to partly privatise its way out of a 10.7 trillion yuan ($1.7 trillion) local government debt problem is music to the ears of investors who have long lobbied Beijing to sell the family silver to shore up faltering finances.
Premier Wen Jiabao's announcement on Wednesday that asset disposals, project transfers and equity stake sales are all part of the policy playbook underlines how seriously the government takes dealing with a problem that analysts believe to be one of a few that could trigger systemic financial risks in China.
But besides giving investors a chance to secure a stake in one of the world's most attractive markets for infrastructure assets, the move signals that a fundamental rethink may have started of the roles of the Chinese state and private capital in industry - a rebalancing that analysts say is long overdue.
"The government should be a small government. In industries where you can exit, you exit," said Leo Zhang, chairman of Jumbo Consulting in Shanghai. "Why do we need over a 100 state-owned enterprises? It's unnecessary. You should sell them all." The state's widespread involvement in banking and industry is blamed by critics for creating huge misallocations of capital, choking the entrepreneurial activity the government says it wants to foster.
With analyst estimates of sour local government loans running as high as 2-3 trillion yuan, mostly on the books of China's big banks, the worst fear of investors was that Beijing would opt to reclassify doubtful debts and declare the problem solved. Wen did not quantify the questionable loans, but he did say action was the only credible answer and that the private sector would be involved.
From land to banks, mines and power plants, China's local governments own a sprawling asset empire that can be sold to investors hungry for a piece of the world's No. 2 economy. As of November, according to a Xinhua report, China had 117 state behemoths managed by Beijing that controlled 24 trillion yuan worth of assets - equivalent to roughly half of the 2011 gross domestic product (GDP). There are also thousands of smaller state businesses.
There's plenty of pent-up demand from international investors for China's growing bond and $2.6 trillion stock markets, and portfolio inflows remain strictly controlled by the Qualified Foreign Institutional Investor programme. In 2011, foreigners were allowed to invest just $1.9 billion, the smallest amount since 2007. But this year, foreign investors are getting more leeway, and so far have been permitted to buy $2.9 billion worth of Chinese bonds and stocks.
Selling profitable infrastructure to investors frees up cash for China to build other roads that could run for free, said David Roseman, global head of infrastructure, utilities and renewables at Australian investment bank Macquarie Group. "There is genuine interest to buy Chinese infrastructure," said Sydney-based Roseman. "It's a massive market. They are spending multiples of what is being spent anywhere else in the world, but most is being spent by the government."
Macquarie Group is one of the world's largest infrastructure fund managers and oversees $100 billion of assets. But its sole China fund barely exceeds $500 million. HSBC estimates China's debt burden is still manageable at 55 percent of GDP, but says the rub is in the cash shortage faced by local governments that could cause "a major bank default."
Faster privatisation would save banks from writing off bad loans, analysts say, while offering a potential solution to another of China's long term problems - the need to create a new range of investment vehicles suitable for pension savings. China officially has 83.7 trillion yuan on deposit at banks, with analysts estimating roughly the same amount is stuffed under mattresses, being eaten away by inflation rather than being put to work to earn interest, support economic growth or create a retirement cushion for a rapidly ageing population.
China has dabbled with privatisation in the past, mainly by shrinking the state's stake in enterprises rather than selling out completely - officially "grasping the big, letting go of the small", an early 1990s model pursued intermittently since. It lets Beijing keep an iron hold on sectors it thinks important, such as energy firms and banks, while privatising smaller firms as it did in mid-2000s to fund pension payouts.
But to many middle-aged Chinese, privatisation dredges up painful memories of the late 1990s when then-Prime Minister Zhu Rongji shut thousands of inefficient state firms and stripped many workers of their jobs to spark faster growth. Although Zhu often wins credit for sowing the seeds of China's economic successes, fears that forceful privatisation would once more propel unemployment and worse, stir social unrest, have kept efforts in check - as has happened in other parts of Asia.
Privatisation is not made any easier by China's complex government ownership structures that stretch across 650 cities and sundry layers, running assets via legions of groups whose interests conflict. Vested interests meanwhile have grown more powerful in China's state-owned enterprises as the businesses themselves have expanded at home and abroad, with many government-backed businesses now multi-billion dollar firms, the stewards of which have no intention of carving up to give to others.
Fraser Howie, chief executive of brokerage CLSA Singapore and author of a book on China's financial system, "Red Capitalism", believes confronting debt is the only way for Beijing to improve the efficiency of capital allocation. "You can call bad debt anything you like. You can roll it over as much as you like," he said. "You still can't get away from the problem that the economics will come back to haunt you - you've wasted the money."
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