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.

---

Hedge Fund 101 - Make Money with Hedge Funds

Investors are always looking for the best investments that will... Read More

Preholiday Trading

The Light Crude Continuous Contract closed at $66.13 a barrel... Read More

Credit Scores = ROI Profits for Real Estate Investors

Strong credit saves real estate investors money on mortgage finance... Read More

It Must Be Joe Cockers Market

Agonizing displays of poor theatrics failed to entertain my mind... Read More

Forex Trading Best Practices

FOREX, the term for the FOReign EXchange market, is an... Read More

Before You Invest You Must Read This

It is important to answer the following questions before you... Read More

Investigate Before You Invest

"Through wisdom is a house built. And by understanding it... Read More

Direcway & Wildblue Set to Square Off this Fall?

There is a cat fight brewing between Direcway LLC, Starband... Read More

Retirement or Financial Freedom?

In the past most people never retired. They died. The... Read More

Invest To Make Money, Not To Get Rich

The technology boom of the '90s romanticized the "rags-to-riches" ideal... Read More

How to Analyze the Veracity of Investment Newsletters

When trying to analyze whether a promotional ad for an... Read More

Critical Options Investing Tip When Trading Naked Calls and Puts

An option is a derivative trading product that is best... Read More

A Secret Revealed: Why Most (Day) Traders Fail

The following perspective on (day) trading comes from my many... Read More

Looking For a Safe Investment? Try a Certificate of Deposit

If you are looking for a safe investment and you... Read More

Mutual Fund Returns May Not Be As They Seem!

Arthur Levitt, during his tenure at the SEC, experienced many... Read More

Investing: Do You Want To Make Money, Or Would You Rather Fool Around?

It always amazes me how much stock market investors resemble... Read More

Realistic Investing Expectations

Over the long term stocks have provided us with great... Read More

Raising Capital in Today?s ?New Economy?

We've helped a number of clients develop business plans and... Read More

The Real Cost of a Bad Habit

What is the value of a good habit? Think of... Read More

Trend Following

Trend following also called momentum trading is the simplest and... Read More

Investing As A Sport?

I said last week that money doesn't generally buy happiness,... Read More

Angels, Are They Real?

They're real, but few survive. High risk investing is dangerous... Read More

To Retire Rich, Save and Invest Early

If you want to retire rich, start saving investing early.... Read More

An Old Dividend Stock Investment Idea, for a New Generation

Death and taxes! The certainties of life! And then, of... Read More

Retirement Plan Considerations Cheat Sheet for Small Business

RETIREMENT PLAN CONSIDERATIONS are something every small business person needs... Read More

Have Analysts Gotten Honest?

It caught my attention when I heard an analyst on... Read More

Success Trading for New Traders: What Does Bid and Ask Mean?

Do you ever wonder exactly what's going on in the... Read More

Investing and Asset Allocation

Sometimes you spend sleepless nights worrying about which stocks to... Read More

How to Invest Overseas - Intelligently!

In recent months, many advisors have talked a lot about... Read More

Short Term Savings Products

When you invest, it simply means that you are putting... Read More

Asset Allocation Lessons: The 70% Inflation Solution

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

Focus Your Investments on the Long Term

"All human power is a compound of time and patience!"... 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