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China to Unleash Market Forces in Arms Sector
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China is mulling policies to restructure most of its defense industry into shareholding companies, a move that would invite private investment and introduce good corporate governance practices.


China has pledged to open up its secretive military sectors to foreign investment, speeding up the restructuring of defense enterprises and encouraging a qualified few to seek offshore stock sales, said the Commission of Science Technology & Industry for National Defense (COSTIND) in a statement posted on its website on June 22. The COSTIND said China will allow foreign investors to "conditionally participate in the shareholding restructuring of China's military companies."


The statement, issued jointly with the National Development and Reform Commission and the State-Owned Assets Supervision and Administration Commission, said companies which design and produce strategic and other major weapons that involve core state secrets and have a direct bearing on national security will still be off-limits to foreign investment.


Work on a draft of the new policy is already underway and will definitely bridge the policy gap--military manufacturers began reforms several years ago but have only made slow progress due to the lack of specific and explicit policies. Of the several thousand companies under China's 10 major military industrial complexes, only 49 have been listed on the local stock exchange after restructuring, mainly through transforming their lines of business from military-oriented ones to civil ones.


Outside investments


The degree of openness to private capital will depend on the importance of the weapons a company produces. Outside investment, including capital from overseas, can be channeled into companies producing less sensitive military equipment as well as goods for the civil and consumer markets.


The statement categorizes the military sector's restructuring into three groups. First, a few key military enterprises with national strategic security concerns and core state secrets will remain solely in state hands. Second, the state will control the stakes of military enterprises that design, assemble and produce crucial weapons and systems. Domestic investment is encouraged to participate in the market-oriented restructuring, incorporation and merger of these enterprises. Furthermore, these enterprises are allowed to lease out, transfer or auction their non-core assets.


The third group is allowed to adopt varied forms of shareholding reform, in accordance with the importance of the weapons they produce, inviting domestic as well as foreign capital to raise money in the capital market.


According to the COSTIND, the military industry's regulator, nearly 1,000 arms makers are allowed to receive investment from overseas, chiefly involving logistics, information equipment, heavy duty machine manufacturing and arms component manufacturing.


"The end goal is to deliver a more market-oriented and innovative industry," said COSTIND spokesman Huang Qiang. "The decision to speed up shareholding reform of military enterprises is conducive to expanding financing channels and taking full advantage of diversified non-state capital to enhance the overall defense industry."


According to Huang, arms makers that meet certain requirements after the reform will continue to receive certificates for scientific research and production of military products.


Ju Jinwen, a research fellow with the Chinese Academy of Social Sciences, believes China's defense sector is moving from a closed and monopolized industry to one that is becoming more open and competitive. Private investment will enhance the innovative capacity of China's arms manufacturing and the efficiency of national defense expenditures.


Luo Kaiyuan, a researcher with the China Information Center, said that economic globalization has intensified competition in the military industry worldwide. As a result, Chinese arms makers have to boost their competitiveness through restructuring and reform. Otherwise, China will further winden its gap with major developed countries in this sector, hindering its defense construction and economic development.


Key issues


Others expressed worries about possible chaos if the state ceases to be the controlling shareholder of some military industrial complexes, since the shareholding reform still remains in its initial stage.


Concerns about the shareholders' right to audit the accounts against the secret nature of military companies top all these worries.


Military expert Song Xiaojun, Editor in Chief of the online version of Naval & Merchant Ships, said the COSTIND would draft a detailed catalogue for the sector to attract private investment in line with the aforementioned classification of the three groups. Besides, the statement makes it clear that military companies should stick to related stipulations on national defense security and technology secrecy while seeking investment overseas, he said.


In the event of offshore stock sales, companies should apply for a confidentiality exemption certificate from state authorities, according to an internal directive issued on May 17. The directive also requires private shareholders to maintain strict confidentiality, asking them to sign agreements against divulging national secrets.


Furthermore, the drafting of a set of related regulations has been developed to avoid such risks. In extraordinary circumstances, the government will impose special regulations on the research and production of weaponry equipment, Song said.


The decision of speeding up shareholding reform of the defense sector, according to Song, is part of the government's efforts to expand the number of listings while introducing certain policies to prevent the stock market from overheating. The ideal choices should be those with potential for technological innovations and good market prospects. They also should be comparatively energy-efficient and pollution-free, play a pillar role in replacing imports and promote the process of industrialization.


Many listed and yet to be listed military companies meet or are close to meeting these requirements, said Song, because "they are producing both civil and military products, and by producing civil products they survive the market economy."


Song is optimistic about the prospects of some military enterprises, provided that there are a complete set of rules and regulations, rational and realistic governance in developing technologies with independent intellectual property rights, and a sound risk-control mechanism against corruption and waste in the operation of projects.




Luo summed up the development of China's military sector into three phases-- the stage of establishment when China built a primary military industry with the help of the Soviet Union in the 1950s; the stage of improvement when a group of military enterprises were founded in the country's western region covering nuclear, aeronautics, astronautics, warships, weapons and electronic products between the 1960s-70s, perfecting the geographical distribution of the defense sector; and the third stage of reform when the Central Government slashed national defense expenditures and shifted the focus of its work to economic development in the early 1980s.


The state introduced a series of adjustments including restructuring, reform, listing and closure to help military enterprises turn into the successful model of arms manufacturers in developed countries.


According to Luo, the Central Government separated China's military enterprises into different industries, including those that lacked competition and thus suffered from sagging efficiency, a lack of flexibility and low vitality. The pressing task is to boost their efficiency through reform in order to gain vitality.


"Arms manufacturers should invite a variety of capital as part of their restructuring efforts," Luo said.


He recommends that the state has less than 51 percent of the stakes in a state-holding enterprise, stating that if the rate rises to 80-90 percent, the shareholding reform won't have an obvious effect.


Huang said that the current restructuring aims to facilitate the reasonable allocation and concentration of military industry resources, improve the innovative capacity of military and civilian technologies, and boost the operational efficiency and competitiveness of military enterprises.


It was quite a different story years ago when China's military enterprises didn't emphasize the market, but instead focused on security and confidentiality.


Huang stressed that military enterprises should target the world market and view the restructuring as a strategic move to enhance the comprehensive competitiveness of the Chinese economy and secure a larger share of the world market.


Yet, the shareholding reform of China's military enterprises can't be completed in the securities market as only a few have been listed in the A-share market.


Huang said that the government will encourage more defense enterprises to achieve the goal of expansion and restructuring through the securities market and invite investment agencies to play a matchmaker role in raising diversified capital.


(Beijing Review July 19, 2007)

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