Thursday, October 29, 2009

BEIJING | The Chinese government has been using its massive stimulus of the economy in part to reverse years of privatization and allow large state-owned enterprises to grab back assets in major industries.

While the Obama administration debates to what extent the state should involve itself in health care, banking and auto manufacturing industries, authorities in Beijing have launched “consolidation drives” - putting pressure on independent steel companies and firms in the iron, coal, energy and airline sectors, among others, to sell majority stakes to state-owned rivals, financial analysts here say.

Under China’s $586 billion economic stimulus plan, banks have been directed to lend to support mergers and acquisitions by state-owned enterprises (SOEs). This disproportionate access to funds, as well as overt government backing, has enabled SOEs to bid aggressively for controlling stakes in privately owned rivals - even when those private companies are more profitable, better-run and in some cases larger than the government enterprises.

“SOEs have gained much more from the … stimulus package than the private sector,” said Xianfang Ren, a senior analyst at IHS Global Insight. “This is inevitable as long as the financial intermediation system, dominated by the state-controlled banking sector, still operates as tools for the government to control and influence the economy.”

The most headline-grabbing acquisition to date has been that of Rizhao Steel, one of China’s most profitable non-state steel mills and, until recently, owned by Du Shuanghua - China’s second-richest man in 2008. (He dropped to 41st this year).

Mr. Du attempted to delay the acquisition by selling a 30 percent stake to a Hong Kong-based investment company, but reluctantly signed off on the deal in September.

The buyer was state-owned Shandong Iron and Steel Group, China’s second-largest steel company, which is controlled by the government of Shandong province and hemorrhaged $188.9 million in the first half of 2009. Rizhao saw profits of $87.8 million over the same period.

Industry analysts said the overall aim of the deal is to help the state negotiate huge iron-ore contracts at lower prices.

The coal industry is also seeing a shake-up, though in this case there might be tangible benefits to society because stronger governmental regulation of Chinese mines is long overdue.

“Many industries are too unwieldy, and the standout is coal; there are a very large number of very small mines,” said Alan Heap, managing director of Global Commodity Analysis, Citi Investment Research.

The consolidation of the coal industry “is not necessarily central control for its own sake - it is primarily an efficiency push,” he said. “The high injury rate is a reflection of poor operating practices.”

In 2008, there were 3,215 deaths in China related to coal mining, making it the most dangerous profession in the country. The number of accidents in small mines is eight times higher than in state-owned mines, according to government officials.

Earlier this year, the provincial government in coal-rich Shanxi province announced plans to cut the number of mines from 2,200 to 100 within the next year, to coincide with a nationwide consolidation to 10,000 large mines. Seventy percent of mine owners in the province have so far agreed to sell, according to state media, though owners were generally offered only a fraction of their mines’ initial development costs.

Consolidation extends to the airline and delivery sectors. In August, for example, East Star Airlines, the country’s fourth-largest private commercial airliner, became the first Chinese airline to go bankrupt this year after it resisted a takeover by state-owned Air China and had its own restructuring plans rejected by a local court. Its bankruptcy leaves just three remaining private air carriers operating in a country that plans to invest $43.9 million in airport construction over the next 12 months.

Last month, authorities announced that the state-owned postal service, China Post, will have a complete monopoly on inner-city express mail under 1.76 ounces and inter-city mail under 3.52 ounces, which basically covers all letters and small packages. This will put the majority of the country’s 5,000 private mail handlers out of business.

“State monopoly remains one major challenge facing the private sector in China,” said IHS’s Mr. Ren.

Not all analysts agree that the state-led acquisitions and re-nationalization are a bad idea.

“I don’t think it is going back to a centrally planned economy. It is all about efficiency,” said W.B Lee, a professor at the Hong Kong Polytechnic University who specializes in manufacturing strategy and industrial policy.

“If the consolidations were in consumer products, I would be concerned,” he said. “But energy and the auto sector, for instance, need to be more centralized.”

Still, the consolidation drive is clearly troubling for private operators across many sectors in China.

Hu Yanping, an analyst at China-based Umetal, predicts the demise of most private players in the steel market. “Chinese private steel companies can’t resist the government-backed takeovers,” he said. “The government’s purpose is too clear and strong.”

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