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SHANGHAI, China - Shanghai Baosteel Group Corp., China's largest steelmaker, plans to pay 3 billion yuan (US$128.5 million) for a controlling stake in smaller regional rival Xinjiang Bayi Iron, the companies said Wednesday.

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Baosteel, state-owned parent company of Baoshan Iron & Steel Co., has pledged to hold onto the newly acquired 69.61 percent stake in Xinjiang Bayi and may increase it, Bayi said in a statement to the Shanghai Stock Exchange.

China is the world's biggest producer and consumer of steel, but its industry is highly fragmented. The government has been encouraging takeovers of small, backward manufacturers by larger, more competitive steelmakers like Baosteel to consolidate the sector and make it more internationally competitive.

Xinjiang Bayi produced 2.84 million tons of crude steel last year, compared to Baosteel's 23 million tons. The acquisition would move Shanghai-based Baosteel toward its target of boosting capacity to 30 million tons by 2010, state media reports said.

"The deal facilitates the consolidation in China's steel sector and improves Chinese steel companies' competitiveness in the international markets," Xinjiang Bayi said in the statement.

It cited Baosteel's advanced technology as a key draw. Baosteel said it was attracted by Xinjiang's location in China's remote northwest.

"The unique geographical position of Xinjiang and its market ties with central Asian countries are a key reason for Baosteel to travel thousands of miles to cooperate with the company," the state-run newspaper People's Daily quoted Xu Lejiang, Baosteel's chairman and chief executive officer, as saying.

The two companies earlier formed a strategic alliance.

The deal, signed late Tuesday in the Xinjiang capital of Urumqi, is still subject to regulatory approval. The local government in Xinjiang retains a 15 percent stake in Bayi.

Baosteel is China's biggest steelmaker by output. It also has a tie-up with rival Ma'anshan Iron & Steel Co. and is reported to be planning an initial public offering overseas, possibly in New York, later this year.

The news boosted share prices for the publicly traded units of Baosteel and Xinjiang Bayi, both of which are traded in Shanghai.

Xinjiang Bayi jumped 10 percent, the daily limit, to 6.17 yuan. Baoshan Iron & Steel gained 1.9 percent to 9.34 yuan.

Some other medium- and small-sized steel makers, such as Daye Special Steel, Jinan Iron & Steel and Tangshan Iron & Steel rallied on hopes that they may also become acquisition targets for industry leaders like Baosteel.