Chinas Great Missed Opportunity

While a U.S. Representative to the Asian Development Bank Executive Board of Directors during the first Bush Administration, I consistently called for China to "bite the bullet" and privatize its 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, incremental 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 a majority of China's large companies are still owned and controlled by the Chinese government has three negative economic consequences.

First, it has stunted the growth of China's financial markets and prevented many companies from tapping equity capital markets. Almost 70% of the shares of China's 1,377 listed companies are substantially owned by the state and cannot be traded. This is the dreaded "overhang" which bedevils the Communist Party leadership and bureaucrats anxious for private Chinese 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, private shareholders are diluted and share prices decline. The use of public funds to compensate private shareholders for this dilution has been considered and rejected as too expensive.

The Chinese government announced a $15 billion buyout fund to invest in state-owned companies but markets are deeply skeptical. My view is that only solution is auction off equity to private investors and de-list poor performers and let them struggle for survival.

Meanwhile private firms hungry for capital are denied a chance to list on these exchanges. The result is that private Chinese companies rely on banks for 99% of their financing! This lopsided dependence on bank financing is unhealthy and furthermore many Chinese banks are bogged down by mismanagement, bloated bureaucracies, corruption and saddled with politically motivated non-performing loans

In addition, China's stock market slump is putting its brokerage firms in intensive care. China's 114 brokerage firms that depend largely on stock trading commissions suffered a 45% decline in revenue in the first half of this year. Trading in the China A shares (for Chinese citizens only) market has virtually 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 so many Chinese companies leads to a lack of transparency and openness that is necessary for China to fully participate as a member of the global investment community. Foreign institutional investors tend to favor investing indirectly in China through the Hong Kong Stock Exchange to gain better disclosure and listing requirements. As an investment advisor, I recommend clients participate in Chinese growth primarily through investing in Hong Kong (EWH) Malaysia (EWM), Canada, (EWC) Australia (EWA), and other Asian countries. The issue of dysfunctional Chinese financial markets has also led to our recommendation to clients that India, not China, may be the best performing Asian stock market in the next ten or twenty years.

The recent announcements of Bank of America and HSBC to invest in two leading Chinese Banks is a welcome step but falls far short of the mark. Both are relatively small investments and both foreign investors will have little authority nor any meaningful management responsibilities. The Chinese want the publicity, the brand and the opportunity to learn but are clearly unwilling to relinquish any control.

Look at what Indonesia is doing to open its financial sector to international investment. International investors are now allowed majority and management control and just last week a large Singapore and Malaysian bank announced plans to make sizable investments in Indonesian banks. The Indonesia government is also drawing up a list of which of its 145 state-owned enterprises will be sold to investors. International investors have taken notice - the Indonesian stock market is doing well and our recommended Indonesia Fund (IF) is up 29% this year.

Third, as the recent high profile cases of Lenovo, Haier and CNOOC demonstrate, as state-owned Chinese companies seek to acquire or invest in foreign companies, the reaction is wariness, skepticism and outright political hostility. The Chinese leadership is trying to groom about 100 of its largest companies to go global in a big way and "brand hunting" of leading multinationals firms with its surplus cash ($700 billion in foreign exchange reserves) is the fastest way to achieve this objective. If you thought the Japanese spending spree during the 1980s was controversial in America ? fasten your seat belt.

The U.S. Congress and other foreign governments will resist these bids since they have little interest in having a foreign government, especially an economic rival enjoying a $200 billion bi-lateral trade surplus, purchase its most prized companies. The issue of Chinese bidders using government financing is also a red flag. Then there is the issue of reciprocity ? foreign companies can only obtain minority interests in Chinese state-owned companies and approval for even these minority stakes is not transparent and highly political.

Finally, there is the broad policy question as to the intent of the Chinese Communist leadership. The slow and grudging pace of privatization could reasonably be read as an indication that the Chinese government has no intention of relinquishing control of state-owned companies. This, in turn, has serious consequences as countries evaluate how to treat a rapidly growing authoritarian country that seeks to participate and benefit in the global economy by using state-owned and state-sponsored companies.

The Chinese adage of "crossing the river by feeling the stones" may be a wise policy at times but in this case a plunge into the river ten years ago would have been much better for the Chinese economy and people. It is by no means too late to take the plunge and the US should be ready to help in any way it can.

Find out more insights at http://www.chartwelladvisor.com

Copyright 2005 Carl Delfeld

Carl Delfeld is head of the global advisory firm Chartwell Partners and is editor of the "Chartwell Advisor" and the "Asia Investor Intelligence" newsletters. He served on the Executive Board of Directors of the Asian Development Bank in Manila and is the author of The New Global Investor (iUniverse: 2005). For more information go to http://www.chartwelladvisor.com or call 877-221-1496.

---

Better Links Directory

Choosing A Financial Advisor

With so many financial advisors trying to woo you with... Read More

When It Comes To Investing, Asking The Right Questions Can Help You Make The Right Decisions

Are you ready to open your pathway to financial independence?Well... Read More

It Is Never Too Early To Start A Roth IRA!

The Roth is kind of weird until you get used... Read More

The Key Ingredient To Increase Preconstruction Profits By Over $20,000

One of the greatest preconstruction investing issues that I hear... Read More

Who Wants To Be A Millionaire?

I am sure you have probably read about the power... Read More

How To Start Investing For Financial Independence, Part 1

Today, I am going to start a multi-part series about... Read More

Overbought/Oversold

Has your broker ever told you that a stock is... Read More

Asset Allocation Lessons: The 70% Inflation Solution

For investors only... and for speculators who need to invest... Read More

My Way Or The Highway: Give Your Financial Professionals A Good Talking To!

All this talk about Investing is encouraging lately. Over the... Read More

Eight Questions to Ask Your Financial Advisor

You may like your financial advisor, but is he really... Read More

Which IRA Is Best For You?

An Ira is one of the greatest ways to save... Read More

Moving Average Convergence Divergence ( MACD ) Charts

The Moving Average Convergence Divergence charts, or MACD charts for... Read More

New U.S. Mint Coins a Golden Opportunity

In April, the U.S. Mint revealed plans to strike in... Read More

Lessons in Transition

Q: What have been the most successful approaches to attracting... Read More

Guru Focused: Robert Olstein?s Short Sells

While it is rather rare that value gurus sell stocks... Read More

Discipline in Investing and Trading

Discipline can be simply defined as your ability to follow... Read More

How to Buy to Let

Find out everything you need to know about buy to... Read More

Why You Need To Buy and Sell Gold Coins (Part 6)

Pre-1933 Gold Outperforms Today's Gold Bullion...Since 1970, an investment strategy... Read More

Keeping It Interesting

Some lines from a movie never leave your mind; I... Read More

Expand Your Pool of Investors for Your Company

If you own a company that sells complicated products and... Read More

Discover the Foundation of Retiring Wealthy - The IRA!

Let me tell you about some legal ways to avoid... Read More

College Savings Plans ? Are They The Best Choice For My Child?

College Savings Plans ? are they the best choice for... Read More

Trading Tips No 3: Online Trading and Investing: Buy, Hold, and Hope

So you have learned how to trade the markets by... Read More

Day Trading the SP Futures with Initial S/R and the NYSE TICK

For instance, if the market moves up in the first... Read More

Well Managed Investing Risks Bring Rewards!

"Risk comes from not knowing what you're doing!" Warren Buffett... Read More