The State Tobacco Monopoly Administration (STMA) has begun to establish the "Big Three" domestic tobacco producers to deal with growing foreign competition.

Local media reported the administration has discussed setting up three big conglomerates to produce seven famous brands of cigarettes.

Administration spokesman Zhou Ruizeng denied that three big groups had already been agreed, but admitted to the plan of establishing large local tobacco producers.

Currently, the overall plan is still in its initial stages and some details have not been fully worked out, Zhou said.

The first step is to establish the major provincial firms, with plans to set up the national giant still under discussion, Zhou said.

Lu Zhongxin, an expert from the administration's economic research centre, said that to set up the provincial flagship firms, the administration has already carried out pilot projects to separate its industrial and commercial wings.

Four provinces -- Anhui, Guangdong, Hunan and Zhejiang -- have been selected as pilots to split the commercial and industrial wings, Lu said.

"All separated tobacco producers will be put into a newly set up provincially based industrial companies,'' Lu said.

"The established provincial tobacco industrial company will try to expand by buying into other tobacco producers in the region,'' Lu said.

Finally, following the example of civil aviation restructuring, these provincial companies will be merged into three to five groups, Lu predicted.

The separation between the two parts is necessary for the administration to build such major tobacco producers, which were affiliated to and constrained by the commercial part, namely, the monopoly trading system, for a long time, Lu said.

In the four pilot areas, Anhui and Guangdong have successfully set up their own provincial industrial tobacco companies, and Hunan and Zhejiang are close to doing the same.

"Then a national reform will start in several months,'' Lu said.

The building of tobacco production giants is believed to be a countermeasure against foreign competition.

British American Tobacco Plc, the world's second-largest tobacco producer and marketer, is reportedly in talks with the Chinese Government to form the country's first tobacco joint venture in Sichuan Province.

Although Zhou denied any possible joint ventures with foreign players, insiders said the entry of more foreign tobacco is inevitable.

Foreign tobacco makers will try their best to enter the market under the name of all kinds of co-operations, Lu said.

"They cannot afford to lose such a big market,'' Lu said.

Each year, Chinese smokers consume 1.7 trillion cigarettes, 30 per cent of annual cigarette consumption in the world.

However, foreign cigarettes legally imported into China have taken only a 3 per cent market share.

The imports are expected to surge as China will reduce its tariff on tobacco according to its commitments to the World Trade Organization (WTO).

The duty rate on cigarettes will drop to 20 per cent by 2004 from the 70 per cent when China entered the WTO in late 2001.

For tobacco leaves, the rate will be cut to 10 per cent from 40 per cent.

The removal of the special retail licence for imported tobacco by the end of this year will also help expand the sales of foreign tobacco, Lu said.

By then, tobacco retailers will not need two licences for domestic and foreign made tobaccos respectively, but just one licence for all tobacco.

Currently, only a limited number of domestic distributors have been given licences to sell overseas cigarettes.

The administration said earlier it will not cancel its monopoly trading system in the tobacco industry, but Lu believed the future will be uncertain.

There are many pressures, Lu said, citing Japan and South Korea as an example. Both countries had to cancel the monopoly system eventually although at first they did not promise the WTO to do so.

"So the most important thing is to improve your strength, firstly in production and then commercially,'' Lu said.

In China, tobacco manufacturers are scattered across the country and are highly regional. They produce more than 2,500 brands of cigarettes.

Eight of the most competitive producers take only 26.4 per cent of the market share.

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