The C&W deal itself is to take place in two phases. The first step saw C&W sell a 5.5 per cent stake in Hongkong Telecom to China Telecom, the operational arm of the MPT, for US$245m.
Pricing, at HK$14.25 a share, worked out at the equivalent to the average price in the three months to June 2, when the deal was concluded. Hongkong Telecom's share price closed at HK$19 on June 6, the night the deal was announced.
The second stage will involve C&W further reducing its holding until both it and China Telecom have stakes of around 30 per cent, expected to happen by the year end. In exchange, C&W be-comes the lead foreign telecoms investor in China Telecom (Hong Kong).
Goldman Sachs of the US has been appointed financial advisor on the creation of the new company, and to lead the public offering. BZW of the UK is advising C&W and China International Capital Corporation, the joint venture investment bank mainly owned by the People's Construction Bank of China and Morgan Stanley of the US, is acting for the Chinese government. ^
Guangdong leads a In telecoms
As in many other industries, the southern province of Guangdong, leads when it comes to telecoms.
At the beginning of 1996 -Guangdong had the highest fixed-line penetration at 26 per cent, comfort-ably ahead of the 20 per cent boasted by Shanghai. As such it has long been a focus for foreign investors, and particularly those from Hong Kong.
By 2000 the number of fixed lines is scheduled to reach 20 million and cellular users to 3.2 million ?out of a population of 64 million.
Internet ambitions also feature on the horizon and the Guangdong Posts
Telecommunications has made no bones about its intention to use foreign investors to achieve its aims. "'The bureau] will make full use of foreign capital and explore new ways of f inancing," 'hen Xuedao, deputy director general of GP&T told the Expo Comm & Wireless Hong Kong '97 Exhibition earlier this year.
Early estimates of China's 1997 grain harvest are around 480m tonnes ?down from last year's harvest of 490m tonnes. Recent floods in the south and drought in the north could push down the final total.
Notwithstanding the perennial concern about the weather, all is not well in the rural sector despite the fact that agricultural reform was a first priority of Deng Xiaoping's economic reforms. Over recent years the focus has shifted to cities, especially in coastal regions, creating a widening gap in regional prosperity and growing discontent in the countryside.
Recently, the agricultural sector has achieved annual growth rates of only about 3.5 per cent ?far behind overall industrial growth. Beijing has woken up to how far the rural economy has slipped behind manufacturing, and it has now placed agriculture to the front of the Ninth Five-year Plan. Agriculture is a key factor in social and economic development, employing over 320 million people ?around 35 per cent of the labour force ?and accounting for about 20 per cent of gross domestic product.
Agriculture's emergence as a pillar industry comes as the government is removing investment incentives in traditional manufacturing joint ventures. New incentives are now being introduced that seek to bring the advantages of free-market reforms to the 69 per cent of China's population that still lives in rural areas. This action aims to reduce the potentially dangerous wealth gap that has emerged between the city and the countryside, and halt the advance of rural migrant workers ?already estimated at over 70 million according to sources within the Ministry of Agriculture.
The key policy aims are to increase rural earnings and maintain a high degree of self-sufficiency in food produc-tion. The first aim will help keep a lid on rural discontent and stem the numbers moving to the crowded cities. It is hoped that increased profitability for farmers will also help to boost farm production levels and reduce the need for imported food, mostly grains.
Grain production has become a barometer for Chinese agriculture generally, but some confusion has resulted from differing definitions and statistics. In China the definition of grains includes rice, wheat, corn, sorghum, millet and other grains, but also covers soybeans, as well as potatoes and tubers, which are left out in the West.
Competition for land
There has also been concern over the ability to measure accurately the country's annual grain production, especially given the size of the country, the small scale of farm holdings and lack of transparency in the measurement system. Official grain production figures may give a true picture of year-on-year trends, but inaccuracies are inevitable. An example of statistical differences is provided by the Minis-try of Agriculture and the State Statistical Bureau, whose independent 1995 grain production figures differed by five mil-lion tonnes. This represented a difference of about one per cent.
The picture of grain production across China is complex. From west to east, China slowly becomes more hospitable and more productive for farmers. It also becomes more urban and industrial, creating intense competition for some of the county's best agricultural land. Cereal output in the coastal provinces of Guangdong, Jiangsu, Zhejiang and Shandong all exceed We tonnes a hectare. By contrast, the inland provinces of Gansu, Qinghai, Ningxia and Shaanxi only produce about three tonnes a hectare. This productivity differential is one of the reasons that of the 30 provinces in China, the top 10 producers account for about 60 per cent of total grain output, while as many as 17 provinces have reported grain deficits. Low productivity is one of the reasons for a deficit, although additional key factors are obviously the ratio of arable land and climate conditions.
Northern provinces such as Heilongjiang and Jilin have abundant surplus grain reserves, while the relative shortage in the south adds pressure to supply chain. This imbalance can cause problems. Despite the initiation of large projects ?some of which are World Bank-funded such as the Northern Grain Corridor ?there are limited storage facilities. In recent years the government has been trucking up to two million tonnes of grain from north to south to balance regional supply and pricing differences. At the same time, prices in the north have fallen due to the over-supply, and special dispensation has been granted to these provinces to export grains, such as corn, even while the rest of the country has maintained a strict export ban. Tariff and other barriers have also been set up on provincial borders to control supplies.
These regional production, supply and pricing issues create a complex picture of the internal grain market which is often clouded by the composite national figures.importing commodities. The result of this debate is likely to have a big impact on grain trade policy in the future.
Currently, China has a healthy agricultural trade balance, with a surplus of US$4.6bn in 1996. Fertilisers and grains, predominantly wheat, are the most important agricultural commodities and both are imported in significant quantities. China is currently a net importer of grain, reaching 20m tonnes in 1995, and 9.4m tonnes in 1996 on the back of a surprise bumper harvest. With a growing population and changing eating habits, imports are likely to continue to increase steadily.
A change in diet
Continued economic development is driving the changes in China's food demand. This is delivering improvements in living standards, and a change in the national diet that will cut the ratio of agricultural output value to processed food value from
Self-sufficiency debate It is clear that feeding a population of 1.2 billion is no simple task ?especially when 13 million people are being added each year, increasing domestic grain demand by around 5.2 million tonnes. Against this background, China faces huge challenges in feeding its people, while balancing the need for a stable rural economy with a desire for low over-all inflation. Stable grain supply and pricing are important tools in implementing this policy.
It appears that the government could be willing to accept a level of around 90 to 95 per cent self-sufficiency in grain, with strategic imports being used to en-sure supply and price control. But whether China should seek physical self-sufficiency in agricultural production, or simply aim for a positive agricultural trade balance, is hotly debated. The political desire to feed its people is contrasted with the economic principle of comparative advantage ?in this case, exploiting China's low cost base to ex-port value-added, processed food, while 100:36 in 1994, to 100:58 by 2000.
Responding to increased demand, meat production has risen from 28m tonnes in 1990 to 58m tonnes in 1996, and is likely to hit 65m-70m tonnes by 2010. This growing demand for meat and processed food will continue to drive indirect consumption of grains, such as feed grain and corn. Currently five kilograms of grain is required to produce one kilo-gram of pork. It is this sort of conversion rate which will drive indirect consumption.
Higher local prices
While grain imports will continue to play a key role in meeting the growing demand, they are unlikely to reach the dam-aging levels suggested by Lester Brown in his controversial book Who Will Feed China?, which predicted imports of 369m tonnes by 2030.
These figures were based largely on assumptions about yield decreases which have since been cast into doubt on a number of counts, including a 1996 study showing a 40 per cent increase in the officially reported amount of cultivated land. Last year the State Land Ad-ministration revealed that its 10-year re-search project indicated that China had 133m hectares of farmland. The previous estimate had been 95m hectares. This newer figure is also in line with estimates based on US satellite information. Based on this more positive picture, the US Department of Agriculture and the World Bank have predicted China's imports in the range of 40m-80m tonnes by 2030.
In 1996, grain production increased by five per cent to 490m tonnes, but this level of growth cannot be sustained. It must be seen against the longer-term production trends which show annual production increases of only 1.6 per cent between 1990 and 1996, and a definite long-term trend of slowing in the annual rate of increase.
Production growth rates are the main variable affecting China's grain import projections, and developments such as large-scale farming, biotechnology, farmer education and profitability will be key issues to watch. China plans to produce 500m tonnes of grain in 2000 but to achieve this, farmers will have to receive financial incentives to production. This means maintaining a high price in 'the domestic market. The fact that grain prices in China are often substantially higher than on the international marketsalso means that the Chinese can use cheap imports to boost reserves and en-sure that domestic prices can be kept at a reasonable level.
In the long term, and as food trade increases, trade barriers may have to come down if China is to be accepted into the World Trade Organisation (WTO). The main members have recently agreed that China will not have to join as a developed country. However, China will be required to work within a defined framework, with measures likely to be phased in over three to 12 years. The process of joining WTO has already be-gun to affect the commodity trade, with China introducing a new tariff and quota structure in 1996. While the new system represents progress, the quota levels have yet to be published.
Lack of certainty
Even where trade is possible, traders have faced problems in estimating China's grain needs. The reserves are a state secret, and flooding and drought can cause sudden changes in the supply picture. The five per cent increase in grain production in 1996 was largely a result of low incidence of natural disasters. Had the harvest been in line with expectations, imports may have risen by 10m tonnes.
Lack of certainty is one reason why the agricultural sector has been slow toattract foreign investment. However, with gove nment focus now on the central and western areas, financial incentives to investment are being introduced for agricultural projects. Central government initiatives, such as land-use reforms and special trade licences, are improving business conditions for foreign investors in agriculture. As a result, investment has grown to nearly US$lbn a year since 1991, bringing the total to US$10.2bn by the end of 1996.
Provinces such as Jiangsu, Guangdong, and Xinjiang are also offering special incentives to agricultural investors, including domestic sales rights, tax breaks and access to funds. As a result of this support, foreign investment in the sector is growing quickly, and the farm sector alone hopes to attract US$7bn in the five years to 2000. Meanwhile, investment has quickly accelerated in poultry and livestock, agrochemicals, processing industries, beverages and food retail.
While businesses will require patience and a long-term strategy, there is little doubt that China will emerge as an important link in the world food system.
China Concept's China Agribusiness Review '96 is being published this month, price US$75. Tel: (44) 171 251 2593 or (86) 10 6518 2518.
Rocketing stock prices among Hong Kong's red chips are drawing the attention of local punters and mainland authorities.
Hong Kong's Hang Seng Index is defying some analysts' predictions of a post-handover correction by continuing to climb far ahead of other bourses in the region, resting close to 16,000 following the resumption of Chinese sovereignty. This marked a dramatic rise over the course of just a few weeks, considering the index scored what was an all-time high of 13,980 on May 14.
Whether or not the boom will continue is now a topic of heated debate in the region. But while the analysts, argue, regulatory authorities outside Hong Kong are taking steps to orchestrate a 'soft landing' for listing-happy mainland companies abroad.
One of the most spectacular aspects of the Hong Kong market has been a steady stream of 'red chip' listings ?initial public offerings launched by Hong Kong companies with Chinese government or quasi-government entities backing them. 'Red chip mania' grabbed hold of Hong Kong in the first half of 1997, with a spate of listings many times over-subscribed and trading, on average, at a price/earnings (P/E) ratio of 30 times. One listing, Beijing Enterprises, was 1,200 times oversubscribed, setting a new record in Hong Kong.
Compared with an average P/E ratio of 17 times for the Hang Seng Index over-all, one wonders whether these mainland-backed firms can perform to expectation. Enthusiasm for red chip stocks stems not from strong fundamentals, but rather from speculative confidence that red chip companies will be able to use their government affiliations to acquire assets at bargain prices and benefit from other preferential policies via their Chinese connections. While few, if any, red chip companies have a track record capable of sup-porting this confidence, local punters re-main undeterred.
By late July, the Hang Seng's red chip index had risen to 3,423, while the H-share index (which tracks mainland companies listed in Hong Kong) was still languishing in a two-year lull at 1,142. This spectacular performance has garnered publicpraise from Chinese officials, but it has also prompted ministerial concern that the red chip phenomenon will begin a haemorrhage of Chinese state assets. Chinese securities officials have already begun to take action.
On June 20, China's State Council issued the Notice on Strengthening Controls over Overseas Share Issues and Listings, which sets out long-awaited rules on overseas listings and related asset injections by Chinese companies. The notice is aimed at increasing Beijing's control over approvals for overseas shares issues and listings. It also aims to deal with current concerns over under-priced asset injections. In light of the market situation described above, both of these goals will impact on listed and unlisted Chinese companies, although the market effects of the notice are more likely to be evident as long-term, incremental changes than as sharp, short-term market corrections.
The notice sets out five 'guidelines' which aim to "ensure the proper procedures for overseas share issues and listings":
Where an overseas registered and I isted company which is majority-owned by a Chinese entity initiates spin-off listings or additional share offers, such activities will be regulated by the local [overseas] securities regulators. However, the Chinese entity backing the company must report the event to the China Securities Regulatory Commission (CSRC) for recording purposes.
Chinese-controlled companies registered overseas (whether listed or unlisted) may use overseas or Chinese as-sets to apply for share issues or listings in accordance with local [overseas] laws, provided that such assets have been held by the company for at least three year.
The Chinese assets of Chinese-controlled companies registered overseas may not be used in overseas share issues or listings if the assets have been owned for less than three years. In the case of "special needs", the matter may be submitted to the CSRC for review, after which the request must be approved by the Securities Committee under the State Council.
Where Chinese assets are transferred to or injected into Chinese-controlled over-seas companies for listing purposes, the Chinese owner of such assets must obtain prior approval at several levels of government within China. Approvals will be contingent on the state's industrial policies; relevant regulations prescribed by the State Council and an overall annual quota. ?Reiterating the principles of the regulations set out in the State Council Notice Concerning the Suspension of Acquisitions of Overseas Enterprises and Further Strengthening of the Administration of Overseas Investment (issued in 1993), Chinese organisations and enterprises are prohibited from using the method, of acquiring controlling shares in an overseas listed company to proceed with 'back-door' listings.
Where enterprises contravene the regulations above, the related share is-sues will be regarded as unauthorised, and the head of the relevant department in charge will be subject to administrative discipline. Offending Chinese enterprises will be punished by the CSRC in accordance with the Provisional Regulations on the Administration of Issuing and Dealing in Shares, and other regulations.
These rules illustrate Beijing's concern to-wards overseas Chinese-controlled companies that are becoming more aggressive in their attitude towards raising capital through listings and additional share issues. It is evidently quite important to Beijing to track their progress closely ?hence the CSRC reporting requirements above ?though how faithful overseas Chinese-controlled companies will be in reporting their bourse activities remains to be seen.
Increasingly, too, the problem of state assets protection preoccupies government officials. It was recently reported by the State Administration of Foreign Exchange, China's foreign exchange and external accounts authority, that China experienced an unexplained outflow of capital totalling US$15bn in 1996. Many economists believe these funds, which equal some two per cent of China's GDP, represent assets funnelled into the stock market for speculation on red chips. The popularity of red chip issues, at least in Hong Kong, could prompt cheap infusions of assets from China to overseas companies.
With figures like these in mind, one might expect further refinements from the State Council, CSRC and other related bodies on the issue of Chinese-owned enterprises and assets abroad, particularly where the overseas bourses are concerned. For now, however, the notice cautions that "Chinese enterprises raising capital in overseas securities markets shall do so mainly by way of direct listings". Hong Kongers will be waiting eagerly for them.
Freshfields is an international law firm. Most of its offices throughout Asia, Europe and North America include China specialists. For further details, contact Teresa Ko in Hong Kong, tel. (852) 2846 3400.
Reluctance to cede control of fixed-line
Fixed-line has been out-of-bounds for foreign companies and despite the need for investment in all areas of the telecoms sector, the cellular side of the business is likely to remain the focus in the near future.
dends for other foreign telecoms companies and while the China Telecom (Hong Kong) deal promises to be the biggest opening to date, it follows a string of smaller encroachments, including:
equipment suppliers such as Nokia and Ericsson have successfully pursued aggressive strategies in China and they have also been innovative in promoting their services whenever new networks are established
home-grown manufacturers such as Great Eastern and Chengdu Cable have raised equity from foreign investors
foreigners have teamed up with Unicorn, China's second telecoms provider, in various cellular joint ventures. These are small projects, worth around US$30m, with revenue-sharing structures.
the involvement of Hong Kong companies with strong China links, such as Champion Technology, in paging and cellular ventures.
Successes and failures
The history of telecoms deregulation in China began in 1994 when Hong Kong companies started setting up the paging and cellular revenue-sharing schemes that prefaced the Unicorn ventures.
One of the most aggressive of this first wave of investors was Champion Technology, which exploited its connections with the People's Liberation Army (PLA) to establish more than a dozen paging operations. The PLA is a popular partner and vital in the world of telecoms because of its hold on radio frequency.
Like another Hong Kong consortium, led by Star Telecom, the Champion businesses are proprietary ?a group, or individual, buys the system in its entirety from the Hong Kong company, which in turn receives a share of revenues generated by the system. In the case of Champion it is around 10 per cent, rising to 40 per cent for the Star Telecom consortium.
It so ayi g an touch while a usmess trip to China can be difficult, +s?cially when the executive spend s-4 of time on the move. Renting a mom phone is one of the easiest solutions, though the service does not come
One of the emerging suppliers, with offices in Beijing, Shanghai and aon. Kong, is PhoneRent ?a partnership between Datron of Holland and Yi Ga local Chinese company.
Telecom and certain local s offer the service but their procedures are more complicate the means of payment more rued
PhoneRent only targets foreigners, and in particular business travellers and delegations. Its phones use GSM tech nology which means they cart. be used' in China's major cities but there are the usual signal problems in the country-side. It also rents out GSM Sim-cards' which enable users to use their own. phones overseas.
Rental rates start at Yn350. (USA) for a single day, failing to US$37 a day ,for weekly rental and US$I8 a day for monthly rental. Some customers rent phones for even longer than one year, by which time they could have paid for a mobile twice over; they cm-rently re-tail for about US$1,000 in Cam. They do this to avoid being cut off for not paying their bills by a certain time and at a certain place.
On top of the rental, PhoneRent u ers have to pay the standard telecom rate for calls plus a 15 per cent service charge and 5.5 per cent tax. In addition, the client has to lodge a Xn000 deposit for loss or damage, for which it is currently not possible to take out insurance cover.
The business of mobile phone rental may come under pressure in future as the price of mobiles in China falls and as echnologies become more standardised. PhoneRent is now looking expand into new areas such as data earth which enable businessmen to send faxes and e-mail while on the road. In a new development, the company hag partnered CITS-Europ Assistance to give customers access to a 24-hour helpline including instant translation information and booking service. The service is available for an additional 10 per cent of the mobile rental fee.
The planned flotation later this year of China Telecom (Hong Kong) stands to give foreigners their first real stab at what has hitherto been a closed market ?the operation of, and equity ownership in, mainland telecoms.
For Britain's Cable & Wireless, which brokered the deal with China's regulator and erstwhile monopoly supplier the Ministry of Posts and Telecommunications (MPT), the move gives it an enviable position at the head of the international telecoms giants jostling to capitalise on China's potential.
While there is much scepticism over just how much access C&W will be given in China "China isn't going to be giving away anything more than it has to," notes one analyst ?it has stolen a march over its peers. What the company gets is unspecified China telecoms projects; what it surrenders is control of Hong Kong's erstwhile monopoly carrier, Hongkong Telecom.
Hongkong Telecom itself ?until the June sale, 59 per cent-owned by C&W ?has been less than successful in securing China deals, in spite of its close relations with the MPT. The MPT is its biggest commercial partner, because around half of all 'international calls' from Hong Kong are made to the mainland.
To date, Hongkong Telecom's progress in China has been limited de-spite these connections and its efforts to avail itself of some guanxi ?hiring Lu Gang son of Lu Ping, Beijing's top man on Hong Kong affairs, to head the China division. Its biggest coups were a management consultancy-style contract on a fibre. optic cable and a mobile project in Beijing. This last project is still without subscribers more than three years after the deal was unveiled. Meantime, Lu junior quit the company in May citing "personal reasons".
However, perseverance has paid divi
There were failures at this time too, like ProdArt Technology, a paging manufacturer which rose during the boom times but suffered a blow when China introduced its austerity measures, forcing companies to prune their communications expenditure.
The following year, 1995, saw the advent of Unicorn, which now boasts around 20 cellular joint ventures with a host of international names including Bell South, Deutsche Telkom, First Pacific of Hong Kong, Telstra of Australia and Bell Canada. Subsequent steps have been taken to introduce new technology platforms into China. A leader in this field is Great Wall, a joint venture between the MPT and the PLA, which signed a framework agreement in the middle of last year with six foreign companies to build trial cellular systems in Beijing, Guangdong province, Shanghai and the inland city of Xi'an. These systems used CDMA (Code Division Multiple Access), which is a relatively advanced standard designed for the more sophisticated user.
The six foreign companies are Motorola, Lucent, Qualcomm of the US, Nortel, Samsung and LG Information and Communications. Great Wall's fledgling CDMA network already boasts 200,000 subscribers, according to Jardine Fleming Securities, which projects five million subscribers ?a 15 per cent market share ?three years from now.
Great Wall is working with Star Telecom and Hutchison Whampoa, the Hong Kong conglomerate which runs a CDMA cellular service in the territory.
Fixed-line out of bounds
What all these examples have in common is that they steer clear of fixed-line projects. This is deliberate as fixed-line is seen as both the most commercially important and the most sensitive part of what is in any case of a sensitive industry. Few communist. states are prepared to open their airwaves to foreign enterprises.
The experience of other Asian countries bent on privatisation programmes has shown that while power plants and toll roads can excite the interest of foreign investors, it is on telecoms sell-offsthat the money really floods in ?and, as the operations become more profit-able, back out to the US and Europe.
Moreover, from a practical point of view, fixed lines are difficult to break up, being reliant on a national infrastructure and subject to a murky regulatory regime which makes it hard to establish who actually operates which element. In China it is especially difficult to split off international and long-distance local gateways which form part of the national infrastructure. By contrast, cellular units can be established in a city or region and hived off as a discrete unit.
It is because of these reasons that analysts reckon the projects to be injected into China Telecom (Hong Kong) will be largely, if not wholly, cellular.
"An international gateway is likely to be considered too lucrative to have foreign participation. Local loop and domestic long-distance networks, on the other hand, are too sensitive to allow foreign ownership," says Mr Dylan Tinker, telecoms analyst at Jardine Fleming Securities in Hong Kong. "Moreover, since an independent regulator and interconnection agreements have not been established, the revenue streams of these di-visions are not yet certain.
"So this leaves cellular. China has al-ready been experimenting with liberalising the cellular field. Over the last few years, Unicorn and Great Wall have devised revenue-sharing agreements that act as effective equity stakes. Now that the State Council has observed foreigners in its cellular industry, it is likely to open up the sector to minority ownership."
He adds that for its part, the MPT knows that a minority stake in its cellular enter-prises could speed up its capital expenditure programme versus its two-year-old struggling competitor, Unicorn. Being a newcomer, Unicorn is strapped for cash while its di-verse list of backers makes it difficult for the company to adopt and follow a stream-lined strategy. But, in a major step forward announced last month, Unicorn is to offer fixed-line services in Tianjin and Chongqing, with consultancy services provided by Sprint and Sumitomo.
Another analyst adds that cellular net-works also have the biggest need for other things which foreigners can pro-vide in addition to dollars ?namely, technical expertise, network management and marketing.
A watershed deal?
The problems of cloning and bad debts which have plagued mobile operators in other parts of Asia, notably the Philip-pines, are also said to be worrying China's telecoms officials who are keen to tap overseas expertise to ensure their mobile networks are not affected to the same degree.
For these reasons, the next wave of market opening after the China Telecom (Hong Kong) flotation is likely to remain focused on the cellular side. However, there is an argument that China will come increasingly under pressure to liberalise from the World Trade Organisation, of which it is seeking membership, and as such may be forced to revise its strategy.
Side-stepping the issue altogether is nothing new for China, which has been endeavouring to publish a telecoms law since 1986. Its efforts still appear to be far from fruition. Interim regulations, to be discussed at the Party Congress in September and codified by the National People's Congress in March next year, could clear the way for pressing changes, such as those necessitated by the upcoming flotation.
Some analysts even question whether the flotation will mark a watershed in telecoms liberalisation in China. "This deal.