Squeeze the cash cows

China: China's state-owned enterprises used to be loss-making white elephants. Not anymore. In 2010, the country's SOEs generated annual earnings close to the size of Argentina's economy. But only a fraction of this was paid to the state. A recent State Council decision to raise the dividend payout ratio to 10 per cent for most firms looks insufficient. Raising dividends further would allow Beijing to increase spending on education and health, while forcing SOEs to become more disciplined.

Earnings at China's 200-odd non-financial companies under central and local government control soared in the past decade, as they enjoyed the benefits of entrenched monopolies and the long economic boom. In 1998, China's non-financial SOEs earned a paltry $3 billion, according to the World Bank. In the first 11 months of 2010, their combined net profit was $274 billion, official data show.

 

But dividend policy has not kept up with the change in fortunes. Indeed, state companies only started paying dividends to central government in 2007. Most SOEs currently save the rest of their retained earnings or invest it in property development.

Starting in 2011, most SOEs will pay 10 percent of their earnings to the Ministry of Finance. But when compared to state-owned companies in other countries - and even the dividends distributed by SOEs' own listed subsidiaries - the payout ratio looks too low.

The average dividend payout ratio of state-owned firms in 16 advanced economies is 33 percent, according to the World Bank. Meanwhile, SOE subsidiaries listed in Hong Kong on average pay out 23 percent of earnings.

SASAC, the body that is the SOEs’ nominal owner, wants them to improve profit margins and return on equity. Lower retained earnings will force the companies to rely more on external financing. Banks and bondholders could play a useful role in enforcing better financial discipline.

The state also has better uses for the cash. If the SOEs had paid 20 percent of their 2010 net profits in dividends the state would have received about $60 billion, more than the annual budget for education and healthcare for 2010.

Asking SOEs to cough up more won’t solve the underlying problem of lack of competition. In the long run, it is in China’s interest to have weaker SOEs. But those reforms will face resistance. In the meantime, it makes sense to squeeze more out of them.