Reforms on hold

Beijing's reluctance to restart World Trade Organisation talks is indicative of the extreme strain placed on US-China relations in recent months. Shortly after Premier Zhu Rongji's unsuccessful visit to the US, NATO accidentally bombed China's embassy in Belgrade. This was followed by the release of the Cox Select Committee report accusing China of stealing strategic military secrets over a 20-year period of systematic espionage.

Reflecting the severe strain placed on bilateral relations, not only has China made no moves to resume WTO negotiations, President Jiang Zemin reportedly directed a review of the sweeping concessions offered by Zhu Rongji in China's last bid for WTO accession, particularly in the area of telecommunications.

While in Washington this April, Zhu Rongji announced an unprece dented policy change by granting foreign firms ownership in Chinese telecoms firms. Beijing reportedly offered to permit 49 percent foreign investment in all services, allowing for a 51 percent share in value-added and paging services after a period of four years following WTO accession. China's commitment outlined in Washington also included a phase-out of all geographic restrictions for paging, value-added and closed-user groups within four years. Cellular/mobile services would be opened in five years and domestic wire line services in six years. The concessions also included opening Shanghai, Beijing and Guangzhou which together account for more than 75 percent of the domestic telecoms market, to all telecommunications services immediately upon WTO accession.

These and other major concessions were considered part of China's final bargaining chip for entry into the WTO. Following failure of the concessions to move Washington, Beijing is back to the drawing board, reassessing the scope of Zhu's offering, particularly in the area of telecoms policy changes. Just as China started making concrete moves to expand the role of foreign investment in its telecoms sector, it looks as if foreign telecoms service providers will face another course of regulatory challenges. Depending on whether China accedes to the WTO this year, current and future telecoms deals may be at risk. In any event, the entry of foreign firms into China's telecommunications services sector will certainly face more protracted delays.

China's telecoms market
For all participants in China's telecoms sector, the stakes are high. According to the Ministry of Information Industry (MII), which now oversees the telecoms sector, total investment in China's telecoms infra-structure has grown at a compound annual rate of more than 60 percent since 1988. Over the past 10 years, China's telephone switching capacity has grown from fewer than nine million lines to an estimated 130 million lines today. During the same period, fixed-line telephone subscribers soared from 4.7 million to 87 million, and mobile sub-scribers grew from 10,000 to the current 24 million.

While impressive, this rapid historical growth does not begin to define the opportunity. China's greatest telecoms growth lies in the future – penetration rates in China are extremely low compared with more developed countries. The fixed-line penetration rate stands at seven percent, while the cellular penetration rate is only two percent.

Both domestic Chinese and foreign firms are eager to be part of this tremendous growth potential. Virtually all of the leading telecommunications firms – both equipment and service providers – have made the China market a top strategic priority. While foreign equipment suppliers have enjoyed varying degrees of success, service providers have been restricted from competing with local providers. Foreign firms and governments alike have lobbied hard to seek changes to this policy, but it has not been until recently that concrete reforms and market access for foreign firms seemed attainable.

Recent structural reforms
In April 1998, as part of a comprehensive government restructuring in China, the MII was formed through the merger of the former Ministry of Posts and Telecommunications (MPT) and the former Ministry of Electronics Industry (MEI). The MII also took over the data transmission functions of several other central-level organisations, including the Ministry of Radio, Film & Television, the State Aerospace Administration and the Civil Aviation Administration (for air traffic control projects). In addition, traditional postal services, formerly regulated by the MPT, were relegated to a new entity, the State Postal Services Bureau.

An important objective of these reforms was to further divide regulatory and commercial functions in the telecoms sector. Another objective was to create greater competition between China's leading telecoms service providers – China Telecom (the traditional monopoly provider of telecoms services) and China United Telecommunications Corporation (Unicorn), a much smaller provider created by a number of central level ministries, but supervised primarily by the former MEI.

However, when most key MII positions were filled with former MPT officials, it was a sign that China Telecom's advantage over China Unicorn would persist in spite of stated policy objectives to the contrary. This has proven to be true. China Telecom continues to dominate the market for basic long-distance and mobile services, while Unicorn holds less than five percent of the cellular market and one percent of the market overall.

In part to address these concerns, the country's telecoms sector is once again going through a major restructuring through the break up of China Telecom. This second round of structural change is designed to liberate local telecoms operators from provincial and central regulators. The move will also increase local competition for the monopolistic China Telecom, strengthen China Unicorn's infrastructure and ability to compete, and introduce foreign investment to the sector.

Creating separate companies
Specifically, MII is in the process of dividing China Telecom into four separate companies responsible for fixed-line, mobile, paging and satellite operations. The paging company and all of its assets have reportedly been separated from China Telecom. The satellite group will run independently as before. The separation of mobile and ground network companies is underway. The four separate companies are expected to be running independently by the end of 1999.

Reforms also aim to put China Unicom in a better position to compete with China Telecom through increased government funding for Unicom and new laws designed to pro-mote fairer competition. They also involve authorisation for Unicom to develop a third network in China based on Code Division Multiple Access (CDMA) wireless equipment to rival China Telecom's infrastructure, based on Global System for Mobile Communications (GSM) technology. To support this, the MII has transferred to China Unicom ownership of Great Wall Telecommunications' CDMA mobile phone networks in Beijing, Shanghai, Guangzhou and Xian. China Unicom is also being supported in its efforts to invest approximately US$3bn to build GSM-based mobile phone networks.

In addition, China Unicom has gained permission to merge with China's largest paging company, China Guoxin Paging Corporation, which has an estimated 60 percent market share and 40 million customers. It is likely that only two of the four new companies created by China Telecom's break-up will be made open to foreign investment – China Telecom for fixed-line services and China Guoxin for paging services. China Telecom Satellite and China Telecom Mobile are likely to remain relatively protected for the time being.

Reducing MlI's level of control
Perhaps the most important aspect of these latest reforms in the government's stated commitment to ensure that telecoms operators will no longer be supervised and managed by the MII. As of June 10, 1999, China's telecoms operators are expected to start reporting to the State Economic and Trade Commission. This move, if successful, is expected to go a long way towards reducing MII's control at the central and local levels. It should also lead to other benefits by fostering greater competition industry-wide, as well as reduce costs, improve service, introduce technology needed to advance China's local networks and services, and pave the way for foreign participation in the sector.

Concessions to foreign investors and the structural changes outlined above are unprecedented for the traditionally restricted telecoms sector in China. Not surprisingly they have created controversy in the upper echelons of the MII and China's State Council. The MII's Minister, Wu Jichuan, has proffered his resignation (which has not been accepted) in protest at the reforms which threaten the monopoly of China Telecom, and may expose China to a competitive global environment for which it is not yet prepared.

Minister Wu has been one of China's most stalwart defenders of policy banning foreign investment in the telecoms sector. He has always based his position on the hope that restrictive policies would provide China's fledgling telecoms sector time to grow strong enough to compete more effectively with global suppliers. In reality tight central government control over the sector has resulted in China Telecom's unhealthy monopoly characterised by an unwieldy bureaucracy, waste, high access and user-charges, and poor service.

Wu Jichuan's offer to resign is a sign of greater liberalisation and rationalisation in the sector, and one that bodes well for future foreign participation in the provision of services. Recent events, however, may strengthen the conservatives' position and result in another step backward for foreign telecoms service providers.

Prospects for foreign participants
The opening of China's telecoms services sector to foreign ownership is aimed at securing two primary objectives. The longer-term aim is to strengthen China's own telecoms services sector and ensure that the county is not left behind the information technology revolution currently underway globally. The shorter-term objective was to gain entry into the WTO. However, after Zhu returned to Beijing empty-handed in late April, his con-cessions are being called a `sellout' by some political conservatives, and are currently subject to review.

While it is too early to draw any long-term conclusions from these recent events, foreign telecoms firms are well advised to temper plans and expectations that may have resulted from Zhu's original offering.

To date, foreign firms have invested funds into China's telecoms sector through quasi-legal Chinese-Chinese-Foreign ventures and other deals whereby telecoms operators (primarily China Unicorn) offer foreign investors a ‘stake' via a share of profits through management, consulting and leasing fees. Several firms continue to pursue these types of deals with the aim of gaining a foothold, and to acquire some operations experience through assisting in the management of the networks they helped build.

The recent agreement between AT&T and Shanghai Posts and Telecommunications Bureau (a local branch of China Telecom) involves joint ownership and management on an internet protocol-based broadband network in Shanghai's Pudong district. The deal, which has still not received official government approval, involves foreign ownership and on-the-ground management. As such, and if approved in its original form and spirit, the venture would be the first of its kind.

The deal, however, faces a serious set of challenges. In the likely event that China retracts either all or a portion of telecoms concessions made during Zhu Rongji's April visit to Washington, foreign ownership in a telecoms venture will come under intense scrutiny as the deal passes through China's cumbersome approval process for large-scale, high profile foreign investments. The deal may not be approved at all, or could be altered so radically as to remove the strategic benefits to AT&T set out in the original agreement.

The US government may also impede AT&T's efforts in China. The Pudong deal will certainly feel the fallout from the Cox report which advocates tighter export controls on all products that have potential military applications, including telecommunications equipment and technology. Future deals involving the transfer of telecoms technology are likely to be evaluated more carefully by both sides. Washington will impose more stringent export controls, while Beijing is sure to think twice before choosing US suppliers over Japanese and European competitors which offer equivalent technology and products without the political ramifications.

Gradual opening
Recent events aside, Beijing needs to utilise foreign capital to build the country's telecoms infrastructure while promoting the success of local firms and protecting its sovereignty. While specific avenues for achieving this goal are currently under review and will probably take some time to define, the long-term outlook for foreign investment in China's telecoms sector remains quite bright.

Concessions unveiled during Zhu Rongji's latest bid for China's entry into the WTO may not be realised as quickly as foreign firms would like, but telecoms reform in China is going in the right direction. Reform efforts in the short-term are likely to result in more transparent legal and operating environments for both Chinese and foreign telecoms operators and a gradual opening of the sector to foreign investment.

This article was written by Tina Helsell (thelsell@hotmail. com), an independent China consultant focused on developing market entry and growth strategies for US Firms doing business in China.