Licking their wounds

Sulking is of course the natural response in China to such setbacks, which are habitually blamed on the efforts of perfidious foreigners to once again constrain China's return to the ranks of great powers.

China has had a chip on its shoulder the size of a boulder for more than a century because of the way it was forced to cede territory to foreign powers at the point of the gun.

To feel humiliated out of such episodes is natural, but to nurture such humiliation and sense of victim-hood, as China continues do over Japan's atrocities during the war dangerously debilitating for the growth of rational politics on the Mainland.

But as one faction sulks, and plots revenge, another arm of China Inc is taking stock of the CNOOC defeat and wondering whether there is a smarter way to do business overseas.

CNOOC has some cause to grumble. It had the higher bid and pledged to sell Unocal's US assets off, thereby debunking the argument that the bid was a threat to US energy security.

Washington's China hawks, however, egged by Chevron Texaco, the rival bidder, prevailed.

But CNOOC stumbled badly at the start, with the Chinese executives and board members hatching the initial bid in secret and ignoring advice that they would have to contend with a political battle as well as a commercial one. By the time they began to sell their bid on Capitol Hill, it was all but dead.

Foreign consultants called in to advise Chinese enterprises on overseas purchases, and some Chinese wise to the ways of the outside world, have long been wringing their hands about the sheer ignorance of local companies in relation to the public relations battle during contested acquisitions.

It is not just a question of refusing to spend money on PR – and who could blame them for that – but a lack of understanding that they are engaged in a political game as well as a takeover bid.

Post-CNOOC, some Chinese enterprises – one suspects with a nod from the top of the propaganda hierarchy – have begun to offer themselves for interview to put forward their side of the case.

Mostly, it is done awkwardly, but at least is a start.

But it is possible to have a soft spot for the Chinese on one level.

Many of the transactions that have been brought to the Chinese come from the "sell side" a polite way of saying that they are being hawked around by investment bankers.

With the aim of creating an auction, these bankers have been leaking the names of potential Chinese bidders to media. The hapless Chinese bidders, who have been struggling to cope with the bid process internally, find themselves buffeted by press calls for a few days, before someone else jumps in to buy the asset.

It is worth remembering that the only successful high-level bid involving a Chinese company – Lenovo's purchase of IBM's PC business – happened in secret. If it was fought out in the full light of day, few doubt it would ever have made it through.

Caution: next steps in the RMB reform

Excerpted from Morgan Stanley's Sept 2 Global Economic Forum notes by Andy Xie:
China is taking tentative steps towards reforming its exchange rate. Many observers applaud the direction and believe that a strong Chinese currency would shift China's growth model towards consumption. This is quite wrong, I believe. Without reforming the political economy to spread income and wealth, a strong currency would only turn China into a poor version of Japan. This is why I believe that China must be careful in reforming its currency regime …

Many observers urge China to increase the value of its currency to boost consumption. This is a dangerous suggestion, in my view. Currency appreciation may boost consumption in a market economy but only when the appreciation is not artificial. China is not yet a market economy. Artificially boosting the currency value would not serve the purpose at all.

A stronger currency is likely to boost the value of bank deposits controlled by a small minority. Their increased purchasing power for foreign goods might lead to more imports of luxury cars or more shopping trips to Paris. It won't boost mass consumption.

Instead, a strong currency would kill economic growth, I believe. Monetary liquidity would decline for two reasons: (1) fewer exports due to cost increases, and (2) lower value of exports translated into local currency. China's overinvestment has kept returns on capital low. The funds for new investment depend on new money from export growth. Without reforming the political economy first, a strong currency policy would turn China into a poor version of Japan.

Excerpted from the United Nations Trade Development Report, 2005:
Correcting global imbalances, or the external deficit of the United States, mainly through massive exchange rate appreciation and lower absorption in China and other developing economies in Asia would have a strong deflationary effect on the world economy as a whole. It would not only render more difficult China's attempts to integrate a vast pool of rural workers and, more generally, to reduce poverty in the country, it would also imply a setback to the efforts of other developing countries to make progress towards the MDGs. Most of the surplus countries in East Asia, and in particular China on which international pressure for revaluation has been the strongest, from both financial markets and policymakers have actively managed the floating of their currencies or have pegged them to the dollar. The sizeable revaluation of any single currency vis-a-vis the dollar could destabilize regional trade and financial relations, in particular, in light of China's bilateral deficits with its trading partners in Asia. It is essential to prevent greater exchange rate flexibility vis-a-vis the dollar from causing higher intraregional volatility. Therefore, if a revaluation of China's renminbi is deemed inevitable as a contribution to an internationally coordinated solution to the global imbalances, it should be sought in the context of a multilateral or regional arrangement … Therefore, if a revaluation of China's renminbi is deemed inevitable as a contribution to an internationally coordinated solution to the global imbalances, it should be sought in the context of a multilateral or regional arrangement.

Excerpted from the World Bank, Beijing office, quarterly report, issued in August, 2005:
A stronger RMB makes exports less attractive for Chinese firms, and makes imports cheaper. This decreases export growth and increases import growth. However, the size of these "expenditure switching" effects is relatively modest in China, limiting the impact of the revaluation on the external current account. A key reason is that the import content of exports remains high, despite the rapid broadening of domestic supply chains. Moreover, investment goods, raw materials, and intermediate goods make up the bulk of imports in China, rather than consumption goods. With the demand for these types of imports less price sensitive, expenditure switching towards imports is limited. Meanwhile, growth in investment, and thus overall domestic demand, is likely to decline as a result of weaker export growth and competitiveness associated with the stronger RMB that make investment in the tradable sector less attractive. The latter effect is likely to be relatively important in China. The dampening import growth resulting from lower growth of domestic activity would partly offset the reduction in exports and increase in imports because of the stronger currency.