China has fared better than just about every other major economy during the global economic crisis, and by some measures may have even benefited from it. Looking back to the start of the year, it’s hard to believe that China might actually pull off an 8% GDP growth rate in 2009. Compared with the stagnation that’s expected in most Western nations, this would be quite a feat.
The global crisis has played an important role in catapulting China to become a major economic influence in the global economy. Battered and bruised, Western policy makers are no longer wagging their fingers at Beijing’s state-controlled policy machine, but are now looking to the Chinese economy to pull the rest of us to our feet.
This shift of economic momentum – and the political clout that comes with it – is obviously not lost on policy makers in Beijing. They are in a position to leverage their sizeable financial resources and move ahead in numerous sectors from automotive to aerospace. Nowhere is this more true than in the financial sector, where policy makers have long aspired to create a robust domestic private equity (PE) and investment banking industry.
Redressing the balance
For years, these areas have been dominated by foreign players who brought overseas capital and enticed many of China’s brightest stars to re-incorporate and list abroad. A lack of institutional investors and experienced management left the market wide open for foreigners to run wild, with government policy serving as the only barrier to keep them from running away with the market altogether.
We are now at a turning point where the stagnation of Western markets, combined with effective policy reform, is shifting momentum from foreign investors to domestic players in China.
With the Western economies still reeling, many investors – including domestic Chinese funds – are beginning to salivate (again) at the opportunities for investing growth capital in China. The policy makers in Beijing are all too aware of the demand, and have shifted policy to further stimulate growth of the local industry.
A spate of reforms – such as allowing renminbi fund managers to raise capital from domestic investors and local governments, streamlining the process by which foreign investors can invest through renminbi funds, and continuing to clamp down on "round trip" investments (i.e. moving ownership of the target company offshore before investing) – have resulted in an explosion of new domestic, renminbi-denominated PE funds.
By all measures, it appears to be working. Nary can I finish one drink at a finance industry cocktail party these days without hearing about someone else starting a new local currency fund. In August alone, 13 China-focused renminbi-denominated funds were established, targeting US$5.48 billion in new capital, up from just US$395.56 million in July. JL McGregor, a China-based research firm, recently reported that investments by domestic funds outnumbered investments by foreign funds for the first time in July.
But is this a sustainable trend? The most important factor in answering this question, I believe, is whether or not China can successfully develop a domestic market for PE investments.
Once again, the policy makers in Beijing appear to be answering the call. The Growth Equity Market (GEM) is slated to open in short order, and promises to serve as China’s NASDAQ, where promising young technology companies can find access to capital. If it performs as advertised, the GEM may indeed be a competitive draw against over-the-counter listings in the long term.
All that said, the domestic markets still have a long way to go. As demonstrated by the volatility of the last 18 months, China’s domestic stock markets are still heavily driven by retail customers, and lack a solid base of institutional investors. Liquidity and secondary offerings also remain thin, which will continue to push the best Chinese companies back to New York and London for access to large pools of growth capital.
Nonetheless, I believe the writing is on the wall: China’s domestic PE industry is here to stay. And as long as the policy makers in Beijing continue to improve their grasp of capitalism, the local PE industry will only grow in size and influence alongside the domestic public markets.