One of the thorniest questions in China is working out the real relationship between state-owned companies and the government.

Ever since the bigger companies started making overseas acquisitions a few years ago, it has also become a diplomatic minefield – notably in 2005 when CNOOC bid for Unocal and set off a political firestorm in the US Congress.

Beijing has been at pains to argue that the big state-owned companies are commercially driven organisations that are forging their own path. And there has been some truth to that explanation – beneath the surface of China’s five-year plans and detailed industrial policies, there has always been intense competition between the state-owned groups which sometimes behave like private fiefdoms, duelling for ever-more territory.

Yet, over the past year, the line has become more blurred. It is much harder to argue that the notion of a “China Inc” is nothing more than a myth. One of the most obvious examples has been the government’s stimulus plan. In 2006 and 2007, it listed three of the large four banks on the Hong Kong stock exchange as part of an effort to reform them into more commercial institutions.

Experienced executives were hired and officials said that politically driven lending was a thing of the past. However, when the economy rapidly started to slow at the end of last year, the authorities reasserted their influence. The chief executives of the main banks were instructed to ramp up lending. Local currency bank credit has risen 164 per cent this year.

The lending has provided a huge boost to the economy. However, the shareholders of the banks will not be so pleased if the credit binge ends up in a wave of new bad loans.

The hidden hand of the state was also evident after Chinalco, the country’s biggest aluminium maker, agreed in February to invest $19.5bn in mining giant Rio Tinto. (The deal collapsed in June).

As this would have been the biggest-ever overseas investment by a Chinese group and involved some of Australia’s most important mining assets, it was bound to be sensitive.

But a few days after the deal was announced, Xiao Yaqing, Chinalco’s chief executive, was moved by the Communist party personnel department to a job in government. Chinalco had to find another chief executive to front the deal.

The biggest blow, however, to the credibility of state-owned industry came in another dispute with Rio Tinto. In July, four executives at the China office of Rio Tinto – Stern Hu, an Australian citizen who ran the group’s China iron ore business, and three locals – were arrested on what was initially described as obtaining state secrets through “improper means”, which in China is equivalent to spying.

With little other information disclosed about the case, many analysts assumed there was a political motivation to the arrests. Rio Tinto had recently cooled on Chinalco’s planned investment in the group – leaving ruffled feathers.

More importantly, along with the two other large miners, BHP Billiton and Vale, Rio Tinto was involved in annual price talks for iron ore with the Chinese steel companies. In the past, the Chinese have complained loudly that the miners behave like an unaccountable oligopoly.

The perception that the authorities were using national security threats to influence commercial negotiations raised a scary prospect for the many multinationals operating in China – that staff could be subject to arbitrary detention or seizure of their assets.

“All the public relations bonanza that China got from the Olympics, all that effort that went into creating a much softer image, all that has been thrown away by this case,” says one long-term China-watcher based in the US.

A month later, the case was transferred from the state security ministry to the local police, allowing it to be treated as normal criminal case, and the charges were reduced to bribery and theft of business secrets. However, the three Chinese executives could still spend some time in jail. And by invoking state secrets in what appeared to be a commercial argument, the damage was already done.

Arthur Kroeber at Dragonomics, a Beijing-based consultancy says: “This forcibly reminded the entire world that the interests of the Chinese state and the big Chinese companies are difficult if not impossible to disentangle.”

It has always been hard to work out in China where state-owned business ends and the government begins. Over the past year, it has become even harder.

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