Originally published by Gordon Orr on LinkedIn: Why Reform of China, Inc. Really Means “Consolidate and Control”

Many China market watchers are hoping that after China’s Party Congress later this year, President Xi will choose to implement an accelerated program to reform state-owned enterprises, exposing them to greater market forces, and with all the redundancies and bankruptcies that this could entail. But they should be careful in what they hope for.

I do believe that there will be a program with the label “reforming SOEs,” but it won’t have much to do with allowing in market forces. Rather, it will be a continuation of the clear trend to increase central government control of what they regard as key industries.

And to consolidate those industries, the Chinese government will reduce the number of Chairmen that the government needs to get into a room anytime it needs to launch a new industrial policy. It is clear that the government prefers a good monopoly, or at least an orderly oligopoly, as their preferred industry structure.

Take for example recent trends in the banking sector. Over the last decade, the share of new loans coming from the big Beijing-based banks has fallen from 80% to only 40%. Growth has come from the smaller city-level banks, perhaps since they are more open to influence from the local than central government. But these smaller banks have a big weakness: they lack deposits from consumers that they can recycle as loans.

Consumers have tended to stay conservatively with the big national banks or riskily move into the murky world of wealth management products. As a result, small banks have had to borrow from larger banks on the interbank market. Now, in a policy move, the government is steadily ratcheting up the interest rate to be paid on borrowing. At best, it will reduce the lending capacity of smaller banks. At worst, it will drive them into financial distress, when the larger banks will undoubtedly step in and absorb them. Stealth recentralization will be the result.

Less stealthy are the likely mergers in the basic materials and power sectors to create maybe four to five vertically integrated giants, such as the discussed Shenhua – Guodian merger. Strong balance sheets merge with the weak, leading to fewer Chairmen for the government to tell how much capacity to add. As a result, the need to worry about the market price for coal will be reduced as it will instead be an internal transfer between divisions. Reform will happen, yes, but not a lot of it will be market-driven.

And almost none will result in material layoffs. Last week, Xiao Yaqing, Director of SASAC, the government’s holding company for the largest state-owned enterprises, highlighted one reason why. He noted that one in four workers in state-owned enterprises is a member of the Communist Party, with the highest share in the largest enterprises. 10 million Party members are working in SOEs in total.