As a U.S. representative to the Asian Development Bank Board of Executive Directors during the first Bush administration, have repeatedly urged China to bite "the bullet" and privatize state-owned companies as soon as possible. Representatives from European and other Asian countries would just shake their heads and mutter about impatient Americans while counseling that China adopt a slow, gradual approach to privatization.
Here we are more than twelve years later and this bullet has turned into a time bomb that could derail China's impressive economic growth and a better life for its people. The fact that the majority of large enterprises in China are still owned and controlled by the Chinese government has three negative economic consequences.
First, it has stunted the growth of financial markets in China and has prevented many companies tapping the capital markets equities. Nearly 70% of the shares of China 1377 listed companies are substantially owned by the state and can not be exchanged. This is the dreaded "bump" that haunts the leadership of the Communist Party and Chinese bureaucrats anxious to private shareholders to have share prices mirror economic growth. The Shanghai Composite Index recently dipped below 1,000 for the first time since 1997. The problem is that when the government sells these shares, the private shareholders are diluted and the share price decline. The use of public funds to compensate private shareholders of this dilution was considered and rejected as too expensive.
The Chinese government announced $ 15 billion buyout fund to invest in state enterprises, but the markets are deeply skeptical. My opinion is that the only solution is the auction capital to private investors and de-listing of poor artists and let them fight for survival.
Meanwhile, private companies hungry for capital are denied the opportunity to list on these exchanges. The result is that Chinese private companies rely on banks for 99% of their funding! This lopsided dependence on bank financing is healthy and also many Chinese banks are bogged down by mismanagement, bloated bureaucracies, corruption and saddled with politically motivated claims performing
In addition, the stock market crash of China is putting its brokerage firm in intensive care. 114 Chinese brokerage firms that depend largely on stock trading commissions declined 45% in revenue in the first half of this year . Trading of the shares of China (for Chinese citizens) market has almost disappeared. The Shanghai Composite Index is down 15% this year. The Chinese government also has an unofficial moratorium on new listings.
Second, maintaining state ownership and control of many Chinese companies leading to a lack of transparency and openness is necessary for China to participate fully as a member of the global investment community. Foreign institutional investors tend to favor investing indirectly in China through Hong Kong for better communication and systems of listing. As an investment advisor, I suggest you participate in the growth of Chinese customers primarily through investments in Hong Kong (EWH) Malaysia (EWM), Canada (EWC) Australia (EWA), and other Asian countries. The issue of Chinese financial markets dysfunction has also led to our recommendation to clients that India, not China, may be the best performing market in Asia over the next ten or twenty years.
The recent announcements of Bank of America and HSBC to invest in two major Chinese banks is a step forward, but falls far short of the mark. Both investments are relatively small and both foreign investors will have little authority, nor any significant management responsibilities. The Chinese want the publicity, the brand and the opportunity to learn, but they are clearly willing to relinquish any control.
Look what Indonesia is doing to open its financial sector to international investment. International investors are now allowed to majority control and management and just last week a major bank in Singapore and Malaysia announced its intention to make substantial investments in banks in Indonesia. The Indonesian government is also drawing up a list of which of its 145 state-owned enterprises will be sold to investors. International investors have taken note - The Indonesian stock market is doing well and our recommended Indonesia Fund (IF) is up 29% this year.
Thirdly, as the recent high profile cases of Lenovo, Haier and CNOOC demonstrate how state-owned Chinese companies seek to acquire or invest in foreign companies, the reaction is distrust, skepticism and even hostility policy. The Chinese leadership is trying to groom about 100 of its largest companies to go global in a big way and chase mark "the best multinational companies with its excess liquidity (700 billion U.S. dollars in foreign exchange reserves) is the most fast to achieve this goal. If you thought the Japanese Spree spending in 1980 was controversial in America - fasten your seatbelts.
The U.S. Congress and other foreign governments to resist these offers because they have little interest in having a foreign government, particularly a rival economic, which has 200 billion U.S. dollars a bi-lateral trade surplus, ITS companies purchase most appreciated. The issue of Chinese bidders with public funding is also a red flag. Then there is the question of reciprocity - foreign companies can obtain minority stakes in Chinese state-owned companies and approval for such non-minority is transparent and highly political.
Finally, there is the broader policy question for the purpose of the Chinese Communist leadership. The slow and reluctant pace of privatization could reasonably be read as an indication that the Chinese government has no intention of relinquishing control of state-owned enterprises. This in turn has serious consequences as countries consider how to deal with a rapidly growing authoritarian country that seeks to participate in and benefit the global economy through state-owned companies and the state.
The Chinese adage of "crossing the river by feeling the stones" may be a wise policy at times, but in this case, a dip in the river a decade ago would have been much better for the Chinese economy and people. It is not too late to take the plunge and the U.S. should be ready to help in any way possible.
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Copyright 2005 Carl Delfeld
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