COLORADO SPRINGS, COLO. – While serving on the executive board of the Asian Development Bank under the first President George Bush, 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. Almost 70% of the shares of China’s 1,377 listed companies are substantially owned by the state and cannot be traded. 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. 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 and corruption and saddled with politically motivated nonperforming loans.
The Chinese government announced a $15 billion buyout fund to invest in state-owned companies, but markets are deeply skeptical. My view is that thinly solution is to auction off equities to private investors while delisting poor performers and letting them struggle for survival. In addition, the Shanghai Composite Index is down 15% this year, and 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, and 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 adviser, I recommend clients participate in Chinese growth primarily through investing in iShares representing Hong Kong (amex: EWH), Malaysia (amex: EWM), Canada (amex: EWC) and Australia (amex: EWA). The issue of dysfunctional Chinese financial markets has also led to our belief that India, not China, may be the best performing Asian stock market in the next ten or 20 years.
The recent announcements that Bank of America (nyse: BAC) and HSBC (nyse: HBC) are investing 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 Malaysia-based 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 (amex: IF) is up 29% this year.
Third, as the recent high profile cases of Lenovo and IBM (nyse: IBM), Haier and Maytag (nyse: MYG), and China National Offshore Oil Corp. (nyse: CEO) and Unocal (nyse: UCL) demonstrate, when 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” 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 that enjoys a $200 billion bilateral trade surplus, purchase some of its most prized companies. The issue of Chinese bidders using government financing is also a red flag. There is also the issue of reciprocity: Foreign companies can only obtain minority interests in Chinese state-owned companies, and approval for even these minority stakes is far from 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 U.S. should be ready to help in any way it can.
Carlton Delfeld is head of the global advisory firm Chartwell Partners and editor of The Chartwell Advisor and the Asia Investor Intelligence newsletters. He served as a director on the executive board of the Asian Development Bank during the administration of President George H. W. Bush, and he is the author of The New Global Investor.
Source: Forbes
Photo credit: Stuck in Customs via VisualHunt.com / CC BY-NC-SA
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