Economic Crisis Spurs Chinese Defense-Industrial Reforms

Following a dismal H1 performance (January – May) for China’s shipbuilding industry (SIB)—new orders received by Chinese shipbuilders decreased by 96 percent year-on-year (yoy), with a net of 1.18 million deadweight tons (DWT)—the sector posted a substantial boost of 8.8 million DWT in new orders for the months of June and July combined. According to statistics released by the China Association of the National Shipbuilding Industry (CANSI), a national association of the shipbuilding trade, in July, the country’s new shipbuilding orders of 4.1 million DWT accounted for nearly 70 percent of the world’s total (People’s Daily, August 17; China Economic Net, August 18). The surge in orders has some observers in the Chinese media hailing a recovery for the ailing industry, which faced a shortage of credit and looming job cuts if the conditions did not improve. Yet, according to some industry insiders and analysts, recovery is far from certain and the real hurdle ahead for the industry will surface in the coming months, when small- and medium-scale ship builders may have to stop production or close down factories, and large builders will be forced to lay off workers and cut salaries (China Daily, July 30). These challenges, however, are buoyed by another trend that may signal changes in the Chinese leadership’s thinking toward further reforms of its defense-industrial complex, in particular, the ability of its defense assets to solicit private funding—starting with the SBI. As a case in point, in the past month, the China Securities Regulatory Commission, the main securities regulator of the country, approved an initial public offering (IPO) in the Shanghai Stock Exchange by China Shipbuilding Industry Corporation, a state-controlled conglomerate that is the largest supplier of capital ships to the Chinese Navy, to issue 1.995 billion shares, or a 30 percent stake, with plans to raise 6.4 billion yuan ($936 million) to expand its capacity (China Economic Net, August 18; Bloomberg, July 23).

At the apex of the sector’s lagging performance, which was due to overcapacity of the shipping market, was a stagnating trade volume in new ships. China’s SBI was also struck by a number of compounding problems, such as order cancellations, ship delivery delays and financial strain. A Ministry of Industry and Information Technology spokesperson described the situation of overcapacity as "acute," and observers placed the blame of the SBI’s falling orders at the feet of the global economic slowdown (China Daily, July 30). These problems, however, may point to further indication of the need for the industry to enact sweeping reforms to overcome its three major bottlenecks: financial (1), technological (2) and managerial (3) (Hong Kong Trade Development Council, April 6). As one industry specialist candidly explained back in 2003: “At the present time, China’s shipbuilding industry has the following problems: obsolete production modes, yet-to-be formed effective technological innovation systems, lack of experienced scientific research personnel, and lack of administrative and management personnel, etc.” [1].

In response to the crisis, the central government committed a considerable stimulus to shore up the ailing SBI. In February, China’s State Council approved a stimulus package for the country’s SBI aimed at encouraging financial institutions to lend more to ship buyers and also offer incentives for purchasers of ocean-going ships. According to one industry expert: "The policy of encouraging financial institutions to lend more to ship buyers has actually helped Chinese shipbuilders to maintain orders. Because of the unfolding financial crisis, many ship buyers feel incapable of forking out the money. This policy has undoubtedly given them confidence and helped cut order cancellations and payment delays" (China Radio International, February 13). Further measures to aid the weakening industry included a 20-billion-yuan (approximately $3 billion) industry investment fund in Tianjin, which would aid in equity investment, ship leasing, supporting mergers and acquisitions among shipyards and purchasing vessels that are cancelled by buyers. Nevertheless, most domestic banks continued lending with caution, despite the country’s top economic planner vow to fund the industry in early June (China Daily, July 2).

More telling of the economic crisis’s implications on the SBI, however, is the effect that it appears to have had on the Beijing leadership’s attitude toward China’s civilian economy and its defense industrial complex—in terms of allowing its defense assets to vie for private funding. The listing of China Shipbuilding Industry Corporation may signal a new willingness by Beijing authorities to loosen its mailed-grip on the sector and publically list its defense assets. The move would establish a "refueling pipeline" between the burgeoning Chinese capital market and its real economy, and boost the development of the real economy. Furthermore, industry specialists believe that the measure could incentivize management, and it gives it a new funding route for its defense budget—as long as it turns over a profit. It is worth noting, however, that commercial shipbuilding has always been considered a strategic industry, since its infrastructure can also support warship construction. Nonetheless, valid concerns over China’s growing naval power may at least be alleviated to an extent by the transparency that listing may bring.

Notes

1. Liu Xiaoxing et al., “The Development Strategy of China’s Shipbuilding Industry,” Chuanbo gongcheng (Ship Engineering), Vol. 25, No. 4, August 2003.