China's EU bridgehead crumbling in Poland

By bne IntelliNews June 13, 2011

Bogdan Turek in Warsaw -

Backed by Beijing and powered by extremely competitive bids, Chinese construction firms have been pushing into Central and Eastern Europe and winning major infrastructure contracts. CEE is seen as a bridgehead to the wider European markets, but that strategy is at risk of already crumbling in Poland.

On June 13, Poland's highway construction authority (GDDKiA) cancelled a contract with China Overseas Engineering Group (Covec), the first Chinese firm to win a major public works deal in the EU, to build two stretches (totaling 90 kilometres) of the A-2 motorway, which will connect Warsaw to the German border via Lodz.

The schedule demands the route be open by the start of the 2012 European Football Championships on June 8, but there are now serious doubts over whether that will happen, with Covec struggling to deliver within the low price with which it won the tender in September 2009.

Work had already halted in May, after the Chinese company ran up PLN130m (€32m) of overdue payments to the 20 Polish subcontractors it hired to provide labour. The subcontractors duly pulled their employees off site, and now the project is already two months behind schedule. Covec spokesman Yang Wencheng says that the company is still talking with GDDKiA and other Polish authorities to seek a way out of the mess. "We are continuing negotiations and cooperation," he claims, without elaborating.

Lessons to be learned

Observers says it's a good lesson for China and Poland, both of which had a lack of experience in striking and managing such infrastructure deals.

Pawel Antonik, CEO of Strabag Societas Europaea, whose company is also working on sections of the A-2, says Covec may have miscalculated the cost of the completing the contract, having bid to build the stretch of motorway for just PLN1.3bn, a price which provoked rival bidders to protest that the Chinese were price dumping.

Critics also claimed that it would be impossible to complete the project for such a price, but the Polish government, presented with a potential tab of around half the amount it had estimated it would have to find, dismissed those concerns.

Antonik says it costs Strabag €8.3m to build 1 km of road, while the Covec contract set costs at €6.4m. However, as he points out, "Covec is a state company, and it's not a secret that the Chinese authorities will subsidise it to enable it to enter the European market." It could be assumed then that Covec will have this option to fall back on rather than abandon the project if it fails to renegotiate the contract with the Polish authorities.

That said, Chinese construction companies in Europe are limited in their usual advantages, Antonik explains. Cheap Chinese construction materials can't be imported as they don't meet European standards, so labour costs are the only lever left to help them slash costs. "However, the cost of labour is generally only 10-12% of the contract in infrastructure construction," he says, calculating that even if they could cut such labour costs by half, the Chinese still can't achieve the kind of competitive edge Covec pushed without state subsidies.

One US manager who worked in China for many years and asked for anonymity says subsidies are a normal procedure there. "When we were bidding against them, they often went for very low-ball pricing, sometimes 50% of the market price, and everyone was convinced they were getting government support. On construction projects, they paid extremely low wages and the workers built their own shelters and slept on boards."

However, Chinese companies appear to be discovering that this model is much harder to implement in the EU. Owning the Stalowa Wola steel mill in southern Poland in March, LiuGong Construction Machinery was reported to be shocked to encounter labour protests in May when it offered a poor social benefits package to the 2,500-strong workforce. "There are still talks with the Chinese on the issue," the Stalowa Wola press office says. "The new investor has not familiarized itself with the working conditions or the labour rules here."

Back on the A-2, Covec officials could only watch as subcontractors pulled their equipment off site in protest at the overdue payments and the Polish workers blocked a nearby road, reported the TVN24 channel. However, this is not the first time Covec has struggled with timing or quality on its overseas infrastructure projects - Polish media claims that a hospital it built in Angola began to fall apart almost immediately, whilst it failed to finish an irrigation project in South Africa.

Counting the cost

Not surprisingly, Cezary Grabarczyk, Poland's minister for infrastructure, is trying to remain optimistic that the problems will be solved soon. "I don't think that the Chinese company, for which a highway construction contract is a sort of a passport to an almost unlimited construction market in the EU, intends to risk its future on the European market," he says.

Just as predictably, the leader of the opposition Law and Justice Party, Mariusz Blaszczyk, claims GDDKiS did not check the credibility of Covec. "There's no way the highway will be built on time."

Meanwhile, reflecting China's strategy to leverage its huge financial muscle to secure a share of European markets, Slawomir Majman, CEO of foreign investment agency PAIiIZ, worries that cancellation of the project would deal a blow to the development of Polish-Chinese economic relations and a number of deals currently under discussion. "Our relations have improved and the flagship for the Chinese was the construction of the highway," he says. "Several Polish companies are about to sign contracts with Chinese companies. A cancellation might scare the Chinese."

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