China Grapples With Failing State Sector

CHINA'S biggest bankruptcy case involving a state-owned enterprise has gone to court on tropical Hainan Island in what could be a breakthrough for advocates of free-market economic reform.Strapped with a $21 million debt and only $14 million in assets, the Hainan Overseas Chinese Remittance Corporation and four affiliates will be dismantled and auctioned unless a creditors' meeting next month produces a sound bail-out plan. The company's plight illustrates how corruption, mismanagement, and economic turmoil bred by China's public ownership system have dragged at least 40 percent of state-owned companies into debt. Whether the gutted firm is allowed to survive will test how far China's reformers can go in using the bankruptcy law to force thousands of failing state concerns to compete - or go bust. "This is a battle between the market and the bureaucracy," says a Chinese source involved with the case. Since the communist nation's first bankruptcy code took effect in 1988, opposition from bureaucrats and fears of labor unrest have prevented all but a handful of small, state-run firms from shutting down. The Hainan case unfolds as Communist Party leaders debate urgent measures to resuscitate the nation's mammoth state sector, which economists warn is on the brink of collapse. Losses by state firms consumed nearly a sixth of government spending last year, contributing to a budget deficit that was 60 percent higher than projected. Profits continue to plunge, falling 34 percent from January to April. Central planners led by Premier Li Peng have so far relied on bureaucratic mandates to "invigorate" the state sector, with huge injections of cash and a propaganda campaign promoting 1991 as "efficiency year." But as such methods fail, Chinese reformers will try to goad state firms to compete, in part by making the threat of bankruptcy real. "Some enterprises ... that are hopelessly in deficit will be ordered to close down," said reform-minded Vice Premier Zhu Rongji last month.

Unwelcome reform The Hainan case, detailed in interviews with key participants and internal documents obtained by the Monitor, demonstrates both the necessity of reform and the powerful interests aligned against it. Hainan set up the Overseas Remittance Corp. in 1984 to supply returning ethnic Chinese with high-grade materials and supplies for construction projects on the island. It expanded quickly, opening soap and furniture factories, trading companies, and a joint-venture hotel. But the firm soon fell victim to China's outmoded state ownership system, which encourages the exploitation of property "owned by the whole people." Internal documents show the chain of graft began with Zhang Changbiao, the corporation's extravagant general manager, whose plush office is flanked by an outdoor swimming pool at Haikou's Wenquan Hotel. Mr. Zhang, now under arrest, has become the prime scapegoat for the firm's undoing. But Chinese sources point out that his excesses depended on the support of bank officials on Hainan, who granted more than $17 million in loans to the corporation. Moreover, officials at the Hainan Economic Planning Department who oversaw the corporation failed to rein in Zhang. From 1986 until late 1989, documents show, Zhang took kickbacks and squandered assets in dozens of deals with private businessmen, causing losses equivalent to $3.8 million.

Embezzled funds For example, Zhang in 1986 hired Qin Baizun, a businessman with a criminal record, to run a soap factory. Over three years, while concealing the factory's sizeable losses, Mr. Qin reaped more than $100,000 in bonuses and embezzled funds. And goods estimated at $420,000 disappeared from factory warehouses. Qin was arrested in October 1989, but he escaped when released on bail for medical treatment. In another deal, Zhang gave businessman Han Xiongguang funds to run a joint-venture trading company with Hong Kong. In October 1989, when Mr. Han fled to Thailand to evade arrest, he owed the company more than $330,000. Labeled "a feudal patriarch" in one document, Zhang also shared the spoils with his clansmen and invested heavily in his home territory, Hainan's Wenchang County. There, he rented 70 acres to breed expensive ducks, fish, and other livestock. With its management and finances in chaos, the firm sank deeply into debt. Losses worsened when Beijing imposed a strict austerity policy in late 1988. Millions of dollars in goods ranging from imported timber and steel to video machines and leather shoes piled up in a warehouse on Haikou's outskirts. In late 1989, Chinese authorities carrying out a nationwide "rectification" of state-run companies exposed the graft and losses. In June 1990, an investigatory team organized by five banks occupied the firm and sealed up its accounts. The decision to file for bankruptcy came in July 1990. The Hainan Economic Planning Department, then led by a newly appointed reformer, Jiang Wei, proposed the idea to Hainan Gov- ernor Liu Jianfeng. Mr. Liu gave written approval and in March of this year, Hainan's Supreme Court accepted the case. "The longer we shoulder this company the heavier the burden will grow," says a Chinese official at the planning department. Surprisingly, the firm's 200-strong workforce has offered little resistance. Hunched over a round of the popular Chinese game mahjongg, idle workers at the firm's dilapidated furniture factory ruled out protests. "We'll just sit at home, unemployed," shrugs Ms. Zhou Yun, a contract worker from Wenchang, before slapping down another plastic mahjongg chip. Instead, the major opposition comes from Hainan bank officials and company executives, who fear losing their positions and privileges, say Chinese sources involved with the case. Bank officials want to skirt blame for allowing millions in bad loans that probably involved taking bribes, the sources say. If the firm survives, the loans will simply remain on bank books. In a last-minute bid to keep the firm afloat, banks and company officials told the Monitor they are negotiating a reconciliation plan. "The company filed for bankruptcy without any discussion. Now we are researching a plan to enliven it again," says Huang Chengji, an official handling the rescue plan at the Hainan branch of the People's Bank of China. "If the economy takes a turn for the better, we can sell our products," asserts Fu Zhen, the company's acting general manager.

Rescue questioned To step up pressure on Hainan's leaders, banks have threatened that if the corporation folds they will withhold loans from other firms on the island. Reformers in Hainan's government argue that salvaging the firm would be unrealistic. Planning chief Jiang says a rescue plan would require banks to grant $4 million to $6 million in new loans and cancel some interest payments. But the banks will only agree to delay repayment of the original loans, bank sources say. Without new loans, Mr. Jiang says, "we must go ahead with the bankruptcy." He indicated, however, that the political concerns of higher leaders could still block the firm's closure. "This bankruptcy case is very difficult to carry out because it would have a great impact. A lot of firms could go this way," he said. "In China, bankruptcy is like euthanasia: Some people say it is good; others say it is criminal."