ON MARCH 27, more than 40 heavily armed police, their guns loaded, burst into one of China's biggest pharmaceutical plants, ordered the shutting down of production and arrested the workers and seven top managers. Their target was a workshop making ketamine, a drug invented in the United States in the 1960s and widely used as a sedative in the Vietnam War, with a price on the black market of up to US$16 million a tonne. Now, nearly four months later, four of the seven managers remain in police custody and three are out on bail. The factory, the Taiyuan Pharmaceutical Company, in the capital of central China's Shanxi province, remains closed. With debts of nearly 200 million yuan (about HK$187.44 million) and its 5,000 workers without pay, nobody knows what to do with it. This is the story of how a state factory, set up with help from the Soviet Union in the 1950s, was forced to make a deal with a prominent drug dealer in order to survive, as recounted by the latest issue of Xinwen Zhoukan (News Magazine). Founded as one of the four biggest pharmaceutical plants in China, it was one of the 156 priority projects established with Soviet help. For 40 years, it had a distinguished record in research and development and produced more than 250 kinds of drugs. But, like so many other state companies, it could not adapt to market competition, especially new joint ventures. A combination of poor management, an inflexible organisational system and lack of capital resulted in heavy losses from the mid-1990s. An official audit in 1998 found the plant had net debt of 94.08 million yuan and should be declared bankrupt. But the Shanxi government was fearful that the 5,000 workers would react with daily demonstrations outside the provincial government headquarters. So it sought desperately all over China for a white knight. Its best hope was the state-owned Hua Bei Pharmaceutical Group, one of the other big four set up in the 1950s, and in 1998 it sent the head of the company 'union' to appeal to Hua Bei to take it over in the interests of 'joint class feeling'. Most of the board was against it, seeing no advantage in taking over an ageing plant laden with debt in an overcrowded market. But a mixture of heavy political pressure and concessions by the Shanxi government forced them to change their minds. The government offered interest relief on the company's loans, no repayment of principal for three years and then repayment over seven years and extended the period of repayment of taxes owed by the old firm. As part of the deal, Hua Bei had to take over the company debt of 170 million yuan. 'From the beginning, it was not a market-driven merger but one made by government. So the defects were already there,' said Hua Bei chairman Lu Weichuan. The forced marriage did not work. Hua Bei did not want to invest any more than 20 million yuan in the factory and insisted that the banks put up the money needed for new equipment. But, owed more than 100 million yuan, the banks were unwilling to provide new funds. Even the personal intervention of Prime Minister Zhu Rongji in October 1999 was insufficient to produce a financial plan acceptable to everyone and in September 2000 Hua Bei announced that it was pulling out of the merger. Last year production stopped completely. Last November representatives of workers went to the Shanxi government to complain, saying that they had not been paid for 10 months, could not meet their welfare payments and that the insurance company had threatened to cut their pensions. They did not even have money to buy coal to keep themselves warm through the harsh Taiyuan winter. This year creditors have gone to court to demand repayment of more than 10 million yuan in money owed to them. It was in such desperate circumstances that the company managers signed the fateful contract on January 16 with one of China's top drug barons, Cao Yongjiang, for three tonnes of ketamine. That day Cao took 100,000 yuan in cash out of a suitcase and pushed it over the table to the factory managers as a Spring Festival gift to the workers. Under the agreement, Cao agreed to invest 40 million yuan in the plant that year. Cao picked the Taiyuan plant because it has a licence to produce the drug, whose manufacture is controlled in China, and had been doing so for 20 years. But Cao was not authorised to purchase and all the documents he produced to show that he was were fake. In March, Cao was arrested in Guangzhou and, when interrogated by police, revealed his agreement with the Taiyuan factory. Now the Shanxi government is back to square one and will find it even harder to find a buyer.