The biggest monthly gain for Chinese stocks in two years is poised to falter should the nation’s new leaders fail to push ahead with reform of state-owned companies, according to the Shanghai government’s investment arm.

The new generation of Communist Party leaders headed by Xi Jinping needs to break the monopoly of government enterprises by introducing more competition and to ease financing for smaller companies to keep economic growth at about 7 percent to 8 percent over the next 10 years, Pang Yang, chief executive officer with the financial-service advisory unit of Shanghai Alliance Investment Ltd., said in an interview at a Bloomberg hedge-fund forum in Shanghai on Saturday.

The benchmark Shanghai Composite Index rebounded 16 percent from an almost four-year low on Dec. 3 after policy makers said they would increase investment in urban development and pledged to deepen economic reform including improving state-owned companies. The benchmark measure posted its largest monthly gain since July 2009 last month and closed 0.4 percent higher at 2,276.99 on Jan. 4, the first trading day of 2013.

“China needs to find one or two drivers to sustain its growth,” said Pang. “Reforms of big state-owned enterprises such as breaking big ones apart and introducing competition can unleash a lot of value.”

Shanghai Alliance is a wholly owned unit of the Shanghai government’s State-owned Assets Supervision and Administration Commission. It takes stakes in companies in industries ranging from alternative energy, information technology to financial services.

Unprofitable SOEs

The eight largest companies by market value in the Shanghai index are state-controlled, data compiled by Bloomberg show. More than 25 percent of government-run enterprises are unprofitable and productivity growth has trailed non-state firms by about 66 percent the past three decades, the World Bank said in a February report. State businesses may become a long-term drag on economic growth, the Washington-based lender said.

The nation’s gross domestic product probably expanded 7.8 percent in the fourth quarter from a year earlier, from a three- year low of 7.4 percent in the previous three months, according to the median estimate of 34 economists surveyed by Bloomberg last month. The GDP data are scheduled to be released Jan. 18.

The government is also seeking to shore up smaller companies on concern slowing economic growth may led to bankruptcies and job losses.

China approved local government financing vehicles in five cities to sell a combined 15 billion yuan ($2.4 billion) of bonds in a pilot program to raise funds for small businesses, two people familiar with the matter said late last month.

Deepen Reforms

The government will “fully deepen reforms” in the economy and “firmly promote opening-up” next year, the official Xinhua News Agency reported on Dec. 17 after the end of an annual conference that sets the tone for government economic policies the following year. China will also seek a higher “quality” of growth in 2013, the report said.

Vice Premier Li Keqiang, who is poised to become the nation’s next premier in March, has promoted urbanization as a driver for economic growth. The move is expected to spur 40 trillion yuan of investment by 2020, the Southern Metropolis Daily reported on Dec. 25, citing a draft plan by the nation’s top planning agency.

The Shanghai Composite climbed 3.2 percent in 2012, its first annual advance since 2009. The index trades at 9.9 times estimated earnings, the highest level in a year, according to weekly data compiled by Bloomberg.

“For the short term, the stock market may have some problems as these reforms take a long time to materialize,” Pang said. “But for the long term, I am optimistic as it looks like the new leaders are quite determined to reform.”