Fran O'Sullivan: Pandering to China on Key agenda

Cheap labour and capital available to Chinese firms will make them tough to out-bid. Photo / Supplied

Prime Minister John Key will launch his own version of "Panda diplomacy" in Beijing today.

Key is well-versed in financial swap arrangements. It's inevitable his, "My two kiwis for your vastly discounted pair of pandas" will provide welcome respite for the travelling media party after a couple of days of full-on trade talks.

But of more interest to New Zealand business will be the extent to which the Key Government might be prepared to pander to China's emerging strategic interest in using NZ as a pilot project for its global infrastructure ambitions.

There has been plenty of controversy over Chinese-led proposals to buy a bunch of NZ farms and form a vertically integrated business which would sell infant formula in China. The May Wang-led bid lacks commercial credibility.

But behind the scenes China is preparing to get out its cheque book and provide cheap state-funded finance so its firms can mount competitive bids to build major New Zealand infrastructure.

This was made clear when the China Road and Bridge Corporation (CRBC) visited Auckland recently on a low-key scoping trip. CRBC was not among the bevy of top-level Chinese firms who accompanied Vice-President Xi Jinping on his official visit to New Zealand.

But the firm's representatives have since outlined how they see the bilateral relationship between China and New Zealand working.

Their basic proposition - "we need your milk, you need our infrastructure" - should not be read as commercial blackmail but as an insight into how this particular Chinese construction firm views the bilateral free trade deal as an opportunity for each country to leverage off its strategic capabilities.

China has long funded and built construction projects in resource-rich nations, particularly in Africa, the Middle East, Latin America and parts of Southeast Asia.

But indications are that China now sees New Zealand as a viable test case for how it will go about competing for such work in other Western developed nations.

CRBC representatives, which included senior engineers, have informally indicated their interest in a raft of roading projects including the Waikato Expressway. Transmission Gully is also understood to have excited interest. Orewa-based Hopper Developments is currently acting as front-end agent for CRBC.

"Ideally CRBC would like to be the preferred bidder," an informed source told the Business Herald. But the Chinese firm understands the bidding process is competitive. Its point of difference is that it is prepared to "bid in finance" as well.

CRBC's fact-finding mission has been a long time in the making.

During the lengthy bilateral FTA negotiations, China indicated it wanted Chinese construction workers to be able to work on NZ infrastructure projects as has long been the practice elsewhere. But New Zealand baulked at the notion that Kiwi workers would be underbid by their Chinese counterparts.

The proposed entry of CRBC into the NZ market will no doubt cause a few ructions with the predominantly Australasian construction companies which develop most of our major roading, bridge and tunnelling projects.

In the wake of the Global Financial Crisis, the Key Government brought forward what it calls the Seven Roads of National Significance as part of its stimulus package.

Adding the giant China Road and Bridge Corporation to the mix will inevitably mean new competitive pressures for prime firms like Fletcher Construction, Leighton Contractors and Hawkins.

CRBC's parent company, China Communications Construction, is ranked at 341st on the Fortune Global 500 list with revenues of US$25.9 billion ($37.3 billion) in 2009.

On its website, CRBC describes itself as a large-scale, state-owned foreign trade and economic co-operation enterprise that focuses on construction of road, bridge, tunnel and port and other transport infrastructures.

But it's not all been plain sailing for the Chinese firm.

Last year the World Bank banned CRBC and three other Chinese firms from bidding on bank-financed projects for 5-8 years after an investigation disclosed they had allegedly rigged bids for a major road construction project in the Philippines.

CRBC's parent company fired back telling the Hong Kong stock exchange the accusation had a "lack of factual and legal merits".

The World Bank has since relented saying the bans will be reduced or terminated if the firms can put in place a satisfactory compliance programme.

CRBC points to its success in constructing famous projects like the Fourth and Fifth Mosul Bridges in Iraq, the Friendship Harbour in Mauritania, Addis Ababa Ring Road in Ethiopia, the North Section of West Kowloon Expressway in Hong Kong, the China-Kyrgyzstan-Uzbekistan Highway and Suramadu Sea-Cross Bridge in Indonesia.

An analysis of Chinese construction firms' entry into Africa found that the lion's share of Chinese financing went to projects in energy-producing countries like Algeria, Angola and Nigeria.

The analysis - which was presented at an International Symposium on Advancement of Construction Management and Real Estate in Sydney in August 2007 - isolated a number of competitive advantages.

"Cost competitiveness derived from access to cheap capital, low-cost labour, and cheap building materials, as well as political support from Beijing channelled through frequent high-level missions and effective on-the-ground communication are the main factors for the current success enjoyed by Chinese construction firms across Africa."

A subsequent study by Stellenbosch University, which interviewed many representatives from Chinese firms, singled out low labour costs, hands-on management style, a high degree of organisation and general aptitude for hard work as major success factors.

The survey authors were surprised that none of their interviewees alluded to their access to relatively cheap capital, which it said was perhaps the single biggest challenge that their competitors face, as part of their comparative advantage.

The state-owned enterprises could secure funds for advance payments from their head offices and also secure loans at flexible rates from Chinese banks such as the Bank of China, the China Development Bank and the China Exim Bank.

In CRBC's case, its management objective is: "First-class service, first-class quality, first-class management, and first-class profits rate."

But the Stellenbosch study found that while local African and foreign construction companies operated on profit margins of 15-25 per cent, Chinese companies usually operated at margins under 10 per cent making them extremely competitive.

An executive representative of a large SOE interviewed in Tanzania (and speaking on condition of anonymity) disclosed that his company and many other SOEs in fact operated on profit margins as low as 5 per cent.

The study reported suggestions by a senior executive at one Chinese company that low profits were maintained in order to increase market share at the expense of local, international and other Chinese companies, with the hope that less viable companies will be weeded out and only the most effective companies will remain.

CRBC's interest in NZ infrastructure should be welcomed. A major Chinese bid would certainly add new competitive cost pressures.

But the Key Government will have to tread carefully.

The real problem it faces is how to ensure a relatively even contest given the Chinese SOE's access to cheap funding and longer-term investment horizons. Something more for Key to ponder on as he talks business with Premier Wen Jiabao in Beijing today.