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State aid helps China tech leaders shrug off US sanctions

Blacklisted iFlytek's subsidy income exceeds its net profit

A number of Chinese tech powerhouses had strong earnings in the first half of 2020 despite sanctions aimed at limiting their access to U.S. technology and markets. (Source photos by AP and Reuters) 

HONG KONG -- While many mainland Chinese companies recorded net losses or substantial profit declines in the first half of 2020, mainly due to the coronavirus pandemic, some of China's tech powerhouses proved immune to trouble.

One company that bucked the trend was iFlytek. The artificial intelligence-based voice recognition technology developer reported a net profit of 258.18 million yuan ($37.7 million), a 36% rise, year-on-year.

iFlytek, based in the eastern province of Anhui, was one of 28 Chinese public institutions and corporations placed on the "entity list," a blacklist compiled last October by the U.S. Commerce Department of organizations with restricted access to American products and technology. The company's interim results, published at the end of August, covers this period of sanctions. Nevertheless, iFlytek remains bullish.

"We were put on the entity list on Oct. 8, 2019. This is possibly because our technology is too advanced," Hu Yu, one of iFlytek's founders and now the rotating CEO, boasted at launch event for new products in Beijing on Tuesday. Washington sanctioned the company for alleged involvement in human rights violations against predominantly ethnic Muslims in China's northwestern region of Xinjiang.

IFlytek, backed by China Mobile, is one of six publicly traded companies on the October entity list that reported strong earnings in the first half of the year. To varying degrees, the solid numbers are attributable to subsidies granted by Chinese authorities at various levels. Other than ZTE, which did not disclose in its results whether it had received government money, the other five companies all received some form of financial support.

Near the end of a 170-page interim report submitted to the Shenzhen Stock Exchange, iFlytek revealed that it received 378.57 million yuan in government subsidies, which is about 50% more than its reported bottom line during the period. The subsidies jumped more than two and a half times compared with the same period last year, allowing it to fully cover what the company called the "expense of dealing with the U.S. entity list" which it put at 46.38 million yuan.

One item listed in the disclosure was 62 million yuan it received from the "Speech Valley" construction fund. Apparently named after Silicon Valley, the initiative by Anhui provincial government, in collaboration with the Ministry of Industry and Information, was set up eight years ago to create a cluster of industries related to AI-based voice recognition technology.

In the company's disclosure last year, before the U.S. sanctions took effect, IFlytek said it received subsidies worth 1.4 million yuan from "Made in China 2025 industrial project." It did not elaborate on this item, but it carries the title of Beijing's ambitious industrial policy that Washington later deemed a major national security threat.

The item was not included in this year's interim disclosure, but the company told Nikkei in an email Friday evening that it had not received funding under this scheme in 2020.

Chang Xiaoming, the company's representative for securities matters, told Nikkei that the company's growth "will not rely on government support." The government subsidy received last year exceeded net profit during the first half of this year.

Another company on the entity list, Xiamen Meiya Pico Information, saw its net profit rise 176% to 3.74 million yuan. It also received a generous dollop of government aid, with subsidies soaring almost ninefold to 33.11 million yuan, which far exceeded its bottom line. The Fujian-based company's main customers are public security and judicial institutions. It sells technology used in forensic data investigations and online censorship. It was a private enterprise until it came under the wing of State Development & Investment Corporation, a centrally controlled, state-owned conglomerate, last July, just a few months before the imposition of U.S. sanctions.

Hangzhou Hikvision Digital Technology, the world's largest manufacturer of surveillance cameras by volume, was the biggest beneficiary of government subsidies among the six companies. It took just under 1 billion yuan in public aid, an increase of 54% from the year before, although the company's disclosure reveals few details.

Neither company has responded to questions from Nikkei regarding subsidies so far.

The Chinese government usually avoids discussing the subsidies it pays to its own companies, especially given that Beijing is trying to present itself as the standard-bearer for the existing globalized economic order in a long struggle against the Trump administration, which sees the current rules of the game as rigged in China's favor.

"The issue of government grants is a complicated one," Huo Jianguo, vice chairman of China Society for World Trade Organization Studies, said in response to this reporter's question when he visited Japan last year. Although Huo claimed there were "no explicit form of government grants at the central government level," one of the top economic advisers to the Chinese government admitted that Beijing has an "industrial policy," and for the local governments, there are policies in place to support certain sectors.

This could be a breach of international agreements, but Huo stressed that "China is now striving to create a fair and legally backed business and commercial environment."

Experts outside China see things differently. "The big trend of increasing the size of government subsidies in order to prop up key industries and maintain employment has not changed," Shinichi Seki, a senior economist at Japan Research Institute, told Nikkei on Tuesday.

As a keen observer of Chinese subsidies, Seki feels "there is a strong belief [on Beijing's part] that industrial subsidies closely linked to their core interests are not negotiable," despite mounting pressure from Washington to fundamentally revamp the policy. Those core interests encompass high-tech, including AI, big data, and semiconductors. So far at least, organizations on the U.S. entity list appear able to brush off the sanctions, thanks to the Chinese government's largesse.

Kenji Kawase is chief business news correspondent for the Nikkei Asian Review and an editor of #techAsia, a newsletter on technology in Asia that combines the best reporting from Nikkei and the Financial Times. He has been reporting and editing for Nikkei since 1992, mainly covering corporate and financial news in Tokyo, Osaka, Shanghai, Hong Kong and Bangkok. He returned to Hong Kong for the third time in May.

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