They tend to live off a diet of drip-fed state subsidies. Even today, many of China’s massive government-owned corporations are addicted to debt as they struggle to tap into new overseas markets.

Fallout from the trade talks between Washington and Beijing about the ballooning deficit, and what the White House perceives to be “forced technology transfer” and “state funding,” is forcing President Xi Jinping’s administration to “accelerate” SOE reforms.

Coupled with the European Union row involving intellectual property rights, the world’s second-largest economy is scrambling to transform these lumbering giants.

“Regardless of the political motivations behind it, this does present an opportunity for China to accelerate reforms for SOEs,” Tian Yun, the director of research at the state-backed China Society of Macroeconomics Research Center, said. “If we continue the way we do business, we cannot stop others from raising doubts.”

Scrutiny has intensified on state-owned enterprises since the ZTE squabble broke out.

The telecom giant was banned last month for seven years by the US Commerce Department from using American suppliers after breaking an agreement hammered out for violating sanctions against North Korea and Iran.

What is striking about ZTE is that it is not a typical telecommunications company. The major shareholder is Shenzhen Zhongxingxin Telecommunications Equipment, which is linked to the state-owned China Aerospace Science & Industry Corporation, the country’s leading space and defense contractor.

This, in turn, has triggered alarm bells in Washington, especially after President Donald Trump’s stance on “forced technology transfer” and the trade deficit with China, which stood at US$58 billion between January to March and a record $375.2 billion last year.

Trump has promised to turn this around, as well as cracking down on Xi’s state-subsidized “Made in China 2025” program, which will propel the nation into a technological powerhouse.

‘System might collapse’

On top of this, the EU last week launched legal proceedings against China at the World Trade Organization for infringing “intellectual property rights.”

“Technological innovation … keeps our companies competitive in the global market and supports hundreds of thousands of jobs across Europe,”  Cecilia Malmstrom, the EU Commissioner for Trade, said. “If the main players don’t stick to the rulebook, the whole system might collapse.”

To combat what Beijing considers a dual threat to its technology industries, the government has decided to speed up “market reforms” to deal with the “accusations, particularly in the West,” that state-owned companies are too closely linked to the private sector and the government.

At last week’s trilateral meeting of trade ministers in Paris between the US, Japan and the EU, the China conundrum appeared to be highlighted in a final communique.

“The ministers confirmed their shared objective to address non-market-oriented policies and practices that lead to severe overcapacity,” the statement said. “An agreement [was reached to] deepen and accelerate discussions regarding possible new rules on industrial subsidies and SOEs.”

Indeed, the final sentence has resonated in Beijing. On Thursday, the state-owned Global Times reported that while “the statement did not mention China by name, it appears to be targeting China because its content and tone are largely in line with the trio’s long-standing criticism of [the country’s] industrial policies and SOEs.”

The English-language newspaper, which is run by the Communist Party’s official mouthpiece the People’s Daily, confirmed that Beijing has started a series of “ambitious reforms aimed at revamping its sluggish state sector by injecting private capital and changing ownership structures.”

Even though the project dates back to 2015, reforms have been incredibly slow in taking effect with the Chinese government still playing a key role in “overseas investment” strategy.

“We did not hear so many complaints a few years ago when Chinese SOEs started to aggressively tap into foreign markets, but as China continues to rise economically, the worry grows,” Tian said.

“US officials and lawmakers have designated China as their No.1 strategic competitor, so you can expect what they will do. The US’ stance has certainly contributed to the overall Western hostility toward China,” he added.

Under Xi’s presidency, Beijing has pressed ahead with reforming the SOE sector and tackling the scourge of “zombie companies.”

Aging and creaking state-owned enterprises are being closed, merged or forced to slim down after binging on overproduction.

“We [have] reduced a lot of ‘zombie enterprises’,” Xiao Yaqing, the chairman of the State-owned Assets Supervision and Administration Commission, told the media at the World Economic Forum in Davos earlier this year. “Now, the management efficiency of the companies [has been] significantly improved.”

Loosely translated, this means they are still around but they appear to have a heartbeat. Data released by the National Bureau of Statistics has supported that view.

A glance at the statistics showed that profits from China’s industrial companies increased by 21% to 7.5 trillion yuan ($1.19 trillion) in 2017, which was the fastest pace in growth for six years.

Infrastructure investment

When you dig even deeper into the numbers, profits at SOEs jumped 23.5% to 2.9 trillion yuan during the same period with total assets of about 151.7 trillion yuan, a rise of 10% compared to 2016. Liabilities also jumped by 9.5% to 99.7 trillion yuan.

Apart from streamlining these behemoths, the government is using them to spearhead infrastructure investment projects for the elaborate $8 trillion Belt and Road Initiative.

These new ‘Silk Road’ superhighways will connect China with Asia, Africa, the Middle East and Europe.

“For a start, I expect the strategy will have a greater positive effect on individual Chinese companies rather than the overall economy,” Ben Simpfendorfer, the founder and managing director at Silk Road Associates, said in a report, entitled A Short Guide to China’s Belt and Road Strategy.

“These are the companies able to identify and execute opportunities in the Silk Road region and so reallocate some of their spare capacity to overseas markets,” he added.

Yet during the past few months, there have been increased concerns about debt issues involving Belt and Road developments with the IMF and an array of Washington think tanks, including the Center for Global Development, highlighting the challenges ahead.

Enhanced transparency and a thorough evaluation of the ability of countries to repay debts need to be addressed, Zhang Jie, a research fellow at the Chinese Academy of Social Sciences, pointed out.

“[But] the claim that B&R projects create high debts for countries is groundless as China values a diversified and sustainable investment mechanism,” Yan Pengcheng, a spokesman for the National Development and Reform Commission, a macroeconomic management government agency, said.

Maybe, it will become a new source of debt for the SOEs to chew on?