As China Woos Overseas Business, State-Owned Firms Take a Hit

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Amer Hilabi / AFP / Getty Images

A man looks at the newly opened, Chinese-built Mecca Metro on Nov. 2, 2010

The 2.5 million pilgrims who flocked to Mecca during the holy week of the hajj, which concluded last week, found it just a little easier to get around the various sacred sites in the teeming city, thanks to a brand new ultra-modern railway designed and built by Chinese engineers. The $1.8 billion line, which connects some of the most holy locations around Mecca, went into operation in early November and can whisk up to 72,000 pilgrims an hour around the city.

But while it may have eased bottlenecks in the Saudi city, the Mecca Metro has caused an uproar back in Beijing since its sponsor, the state-owned China Railway Construction Corporation (CRCC), revealed that it suffered a staggering $600 million loss on the project. As much as the new rail system itself is a showcase for China's fast-developing high-tech prowess, the budget shortfall — the largest loss any Chinese company has ever recorded on any overseas initiative — is also a showcase for China's willingness to dig deep into its coffers to curry favor internationally.

As an exhibition of Chinese technology, the Mecca Metro has been a huge success. Replacing a fleet of some 4,000 buses around the city, the high-speed train system handled hundreds of thousands of pilgrims last week without a hitch. The entire project was brought to completion just 16 months after CRCC inked a contract with the Saudi government, but what unfolded during those 16 months underscores the enormous risks facing the state-owned enterprises, or SOEs, handpicked by Beijing to deliver on political promises to new friends around the globe.

While much of the history of the Mecca Metro project remains opaque, what is clear is that ever since its inception at a signing ceremony in February 2009, witnessed by China's President Hu Jintao and King Abdullah of Saudi Arabia, political motivations have trumped commercial sensibilities at every turn. Indeed, it is not clear how much CRCC even knew about the details of the project as their executives joined Hu and King Abdullah to sign the deal with the Saudi Ministry of Municipal and Rural Affairs. And as one of China's "central state-owned companies," CRCC had little option but to accept the Mecca Metro mandate. The 150 or so central SOEs are majority state-owned and heavily government controlled, to the extent that their CEOs are ranked as vice-ministerial-level officials. What they would have known, at least, is that with Hu alongside them, this was a political project first and foremost, and that meant that failure was not an option.

According to reports in the Chinese media, as soon as the deal was confirmed and CRCC was locked into a set-price contract, the Saudi partners at the Ministry of Municipal and Rural Affairs immediately began to redesign their requirements and shift their parameters. A project that had been planned according to Chinese industry standards now had to be built to U.S. and European specs, significantly increasing expenses. The passenger capacity was revised (upwards), while the amount of earth that had to be shifted doubled from the original plan. To make matters worse for CRCC, the Saudis insisted on using their own subcontractors for all work instead of the cheaper Chinese crews CRCC had planned on importing. The Saudi government also delayed the relocation of thousands of people along the planned route, pushing back timelines.

As losses mounted, CRCC had little choice but to grin and bear it. With a project team led by CRCC's CEO Zhao Guangfa, Minister of Railways Liu Zhijun, and his vice minister Lu Chunfang, the project was being watched closely, both by Beijing and by its Saudi allies. "The construction of a railway in such a sensitive area, in itself, had very strong political reasons," says Yin Gang, a researcher at the Institute of West Asia and Africa at the Chinese Academy of Social Sciences (CASS). "And if a Chinese company stopped working in the middle of such a sensitive project, the losses incurred would not just be economic."

While CRCC may have gained brownie points both in Beijing and the Middle East for its largesse, investors in Hong Kong where the firm is listed were less sanguine when the $600 million loss was revealed. CRCC's share price plummeted nearly 14% on October 26, the day after the announcement, and has yet to recover. And while its losses were unprecedented, CRCC is far from the only SOE to find itself mired in an unprofitable project in a faraway land. "There are a number of other cases where Chinese companies didn't lose money on a project [overseas] but they didn't make any profits either," says Yin Gang of CASS. "A couple of years ago, a Chinese company built an oil pipeline in Libya and didn't make any profit at all."

While Beijing is eager to gain influence and allies in sensitive areas around the world, it is also aware of the tremendous potential business opportunities for Chinese companies in emerging markets like the Middle East. Chinese companies are becoming increasingly active in bidding for projects in the Middle East, and are offering cheaper prices to secure contracts. "Chinese companies have been bidding at remarkably low rates [for projects in the region], partly to gain market access and also partly because the Middle East, at the moment, is one of the world's biggest capital-projects markets and one of the few markets where governments are still building capital projects," says Ben Simpfendorfer, chief China economist at RBS and author of The Silk Road Economy, a book about Sino–Middle East trade.

Some, however, question the wisdom of lavishing $600 million in distant lands in the vague hope of gaining some future influence. "Even though China is enhancing economic communication with Middle Eastern countries, this doesn't mean there is a change in China's political status or geopolitical factors in that region," says CASS's Yin Gang. "The CRCC case is a lesson for Chinese companies — from this they can gain a lot of experience."

Experience, certainly, but it remains to be seen if the Mecca Metro project will actually translate into more business opportunities for Chinese companies. Even the metro itself only showcases China's prowess for six days a year. After the week of the hajj, the rolling stock was mothballed, and it will remain under wraps for another 12 months.