The mixed messages that emerged last month over Swiss bank UBS’s bid for a stake in brokerage Beijing Securities were thoroughly in keeping with the climate of uncertainty shrouding large-scale foreign investment in China.
Judged on the basic facts, the deal makes perfect sense: a key member of China’s troubled brokerage community – which, as a whole, lost US$1.8 billion in 2004 – can wipe out some of its debts with a US$212 million injection of capital; the foreign investor takes a 20% stake and management control of the brokerage so the mistakes of old are less likely to be repeated; and, hopefully, the brokerage blazes a legal and profitable trail for others to follow.
The government has closed 20 brokerages in the past 18 months but 110 is still too many – consolidation is inevitable and regulators will sleep sounder in the knowledge that there are fewer horses out there to trip. What no one could account for was the severe bout of second thoughts the leadership succumbed to around the start of the year, which has seen foreign investment in China’s financial industry put on hold and large deals in a number of other sectors called into question.
Given the anti-privatization sentiment expressed by numerous academic and political sources over the last few months, it is quite possible that the reform-minded factions of the government saw this backlash coming. In the interests of economic stability, it could have been decided to put the brakes on big investment deals until the "liang hui" – Chinese People’s Political Consultative Congress and National People’s Congress – were out of the way.
After all, who in their right mind give the opposition controversial issues to play with at the political showboating event of the year? The "opposition" may be fellow party members with slightly different shades of political philosophy, and the NPC is well known as a rubber-stamp parliament – but reports still filtered out of divisions over the role foreign ownership should play in China’s economy. Approving a multi-million dollar foreign investment deal in the middle of all this wouldn’t have helped.
War of words
The reformist-conservative to-and-fro was still alive and kicking last month as two economists hit back against the critics of foreign investment. Wu Jinglian, a former head of the cabinet’s economic think tank, said the conservative opposition amounted to advocates of the failed state planning system who had used issues such as the urban-rural income gap and "redirected it into opposition for market reforms".
Fellow academic Xu Xiaonian invoked the spirit of Deng Xiaoping, saying that any movement away from the path of reform would be an abandonment of the 1979 opening up policies. Both men effectively called on the state-controlled economy to step aside on issues where the free market could do a better job.
For every glorious leader’s legacy dragged into play, one feels the weight of several months being added to the shelf life of a debate. In the current smoke-and-mirrors climate – and by the time you read this, who knows what events may have transpired in the foreign investment soap opera – decisions on investment applications are like to be made slowly and on a case-by-case basis.
There are some situations, such as with brokerages, where the need is so great that foreign capital and know-how are the only logical solution. The UBS-Beijing Securities deal has taken a long time making its way through the red tape because it involves a precedent – awarding management control of a domestic brokerage to an overseas institution.
The Citigroup dilemma
Things are even more delicately balanced in the Citigroup-led consortium’s bid for an 85% stake in Guangdong Development Bank. The US bank hopes to receive a shareholding well beyond the 20% limit for foreign ownership of financial institutions allowed under current rules, much to the irriation of rival bidder Soci?t? G?n?rale. Given that approval for the deal would be denounced by the conservatives as the thin end of the wedge for foreign ownership and could well intensify pressure from HSBC for greater control over Bank of Communications, is it really worth it? The Guangdong bank is in dire straits, but someone else’s money is just as good as Citigroup’s.
But it takes only a trip down the road to Shenzhen for the precedent argument itself to be brought into question. Last year, Newbridge Capital bought 18% of Shenzhen Development Bank and received approval to become the first and, so far, the only foreign investor to get management control of a Chinese bank.
A precedent was set and it was done by an equity group that bought into Korea First Bank in 1999 and sold out at a 400% profit less than six years later. Fair enough, Newbridge took the risk and turned the bank around. But this is of little comfort to fellow venture capitalist Carlyle.
The group’s US$374 million bid for an 85% stake in construction equipment manufacturer Xugong has apparently been derailed by concerns about selling equity to investors with a tendency to cash out when the price is right. While the Carlyle bid represents a takeover to Newbridge’s minority stake, there are no official restrictions on foreign investment in the construction sector.
Buying a stake in a Chinese firm has always involved navigating through some particularly murky waters – the devil is in the details and, with a host of local political and practical issues to consider, no two deals are the same. The current climate of antagonism towards foreign buyouts only adds to the confusion.
Potential investors would do well to wait out this phase rather than walk away. China needs to resolve these domestic tensions, but the myriad linkages with the outside, including equity stakes, can only grow.
A meeting of minds
As meetings go, this particular encounter had an interesting billing: on one side of the table, the perceived arch-manipulators of China’s currency and, on the other, the politicians calling for a 27.5% tariff on all Chinese exports to the US if the yuan isn’t revalued by a similar amount.
Given the months of pointed US criticisms and spirited Chinese comebacks that had preceded this sit-down, a bout of diplomatic trash-talking might have been expected. But, as it turned out, Senators Charles Schumer and Lindsey Graham came, saw, shook the appropriate hands and said they were satisfied that Beijing was committed to currency reform. The vote on their bill, originally due for March 31 was duly put on hold.
It was always likely to be this way. For a start, Schumer and Graham, a Democrat and a Republican respectively, were never going to sour Sino-US relations to the extent that President Hu Jintao’s trip to Washington would be disrupted. But most importantly, whatever the bravado attached to it, there is little chance that the Schumer-Graham bill will ever pass – it has become the hot potato of American politics.
The US manufacturing lobby has complained long and loud that a deliberately undervalued yuan makes Chinese goods artificially cheap and suffocates their American counterparts. But members of congress would rather take a trade union tongue-lashing than have to go back to their constituents and explain why the price on all Chinese-made goods has increased by a more than a quarter.
Even when production lines are switched elsewhere – and Wal-Mart can’t exactly decamp from China overnight – the public would still end up out of pocket as retailers pass on to the consumer both the logistical expenses and the small premium for using only the second-cheapest emerging market option. Needless to say, this won’t save any jobs in the US.
China’s trade surplus – which totaled US$23.31 billion for the first quarter, a 41% rise on 2005 – requires attention, but a turnaround cannot be achieved instantly. A European Commission report made this very point, saying that "China should introduce greater exchange rate flexibility in a gradual manner".
The report warned that a sharp rise in the yuan against the dollar would put the brakes on capital flows to the US, which could lead to a fall in the dollar against the euro. European exports to the US would become more expensive and therefore less attractive, jeopardizing the EU’s hopes for economic recovery. This may be a European perspective, but the message is the same the world over: exchange rate volatility means trouble – so a sudden 27.5% appreciation in the yuan is not the answer.
Schumer described his meeting with officials including People’s Bank of China Governor Zhou Xiaochuan as "a meeting of minds", and well he might. After all, Zhou isn’t anti-reform – he just wants to achieve it at a slower pace so as to avoid putting unnecessary pressure on a financial system that is not yet robust.
It all amounts to a test of patience and of faith for US politicians. The Schumer-Graham bill is one of 15 pieces of legislation on restricting Chinese trade making their way through the US bureaucracy. The most dangerous of these could well be a proposal to leave retaliation in the hands of the US Treasury Department.
The Treasury’s latest report on exchange rates was due at the end of April. It has so far resisted calls to brand China as a currency manipulator – but how long can it hold its nerve on the issue?
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