* I published this post before it was complete so several changes have been made since Sat July 16th *
Everyone is enamoured with China and its growth. Just look at a list of recently published titles about China on Amazon.com –
China, Inc. : How the Rise of the Next Superpower Challenges America and the World
China: The Gathering Threat by Constantine C. Menges
The Chinese Tao of Business: The Logic of Successful Business Strategy by George T. Haley
China Streetsmart: What You MUST Know to be Effective and Profitable in China by John Chan
China’s New Order : Society, Politics, and Economy in Transition by Hui Wang
The China Dream: The Quest for the Last Great Untapped Market on Earth by Joe Studwell
The Chinese Century : The Rising Chinese Economy and Its Impact on the Global Economy, the Balance of Power, and Your Job by Oded Shenkar
The World Is Flat: A Brief History of the Twenty-first Century by Thomas L. Friedman
Harvard Business Review on Doing Business in China (Harvard Business Review Paperback Series) by Harvard Business School Press
Mr. China : A Memoir by Tim Clissold
Three Billion New Capitalists: The Great Shift of Wealth and Power to the East by Clyde Prestowitz
But the problem with doing business in China is that its virtually impossible to earn a good return on investment. A company has to promise millions of investment dollars be spent in China before the the government grants access to a market. In addition, there’s no guarntee that patents and intellectual property will be enforced rather than stolen. Finally, after all the investment, it’s difficult to turn a profit given the poor management practices in China and in turn bring cash out of the country.
The difficulty in being able to turn a profit in a country that sports such high growth is illustrated perfectly by China’s Shanghai stock market. As Todd Harrison teaches over at Minyanville.com, the variables that affect stocks are 1) fundamantal, 2) technical, 3) psychological and 4) structural. I think the biggest problems with the Shanghai Index are funamental and structural.
First, many companies on the exchange are recently spun off government entities that have barely turned a profit based on questional accounting practices being administered by poor management. I can’t really think of any bigger fundamental problems than those.
Second, and probably the most problematic in my mind, is that China is still a Communist country. Any investment made in China needs to be made understanding that a 100% loss is within probabilities. If the wrong leader comes into power (Putin in Russia), the government can simply decide to seize the assets. And in that instance, business have no recourse. If you think the Supreme Court reduced our rights with its ruling on government’s power of using eminent domain, you should move to China, where at the end of the day, the government has eminent domain over everything.
So until the government comes up with better plans than buying stock in the open market, the structural and fundamental issues in China will most likely keep pressure on the stock market.
If you don’t believe that structural issues exist, look at the Hong Kong Hang Seng market, on which many Chinese companies are listing. It recently broke out of a trading range and is moving to multi-year highs.
So before you learn Manderin Chinese so you can become a king-pin investor in China, read the following great article about China by The Scotsman paper.
Sun 17 Jul 2005
Welcome to the land of profitless prosperity
ALLISTER HEATH and GRANT CLELLAND
THE head of one of China’s big-four banks was in effusive mood. Entertaining Hong Kong journalists over a lengthy lunch at his bank’s headquarters in Beijing, he ran through the reasons why foreign investors should rush to buy equity in his financial giant.
China, he said, was a land of unlimited opportunities, with a growing middle class and an impressive savings rate, yet with an underdeveloped banking system ripe for reform.
And who wouldn’t want to invest in a country with a highly productive, well educated workforce able to make the goods the West wants at prices that could undercut anywhere in the developed world? What capitalist, he asked, could afford to miss such an opportunity?
It was only when he went on to talk about his bank that he stumbled. No, he couldn’t put a figure on the size of the bad loans his company faced, because he didn’t know how many of the loans could be called "bad". In fact, he didn’t know how many loans the bank had made, because no record of such apparent trivia was kept by an institution whose role had largely been to lend to firms at the state’s whim, regardless of whether they would be repaid.
No, he wouldn’t be able to say how many branches the bank has, or how many employees, because those records didn’t exist.
The bank remains unprivatised and the banker, vaunted at the time as one of the country’s best, is now in jail on corruption charges.
The story is from the spring of 2001, but illustrates the paradox at the heart of doing business in China. In a world where returns on investment remain stubbornly low, at least outside a few bubble areas such as housing, China’s impressive growth rates – officially 9.4% a year in the first quarter – are alluring for Western bankers, businessmen and investors.
Yet China remains very far from being a well-functioning market economy and there are glaring holes in its financial and legal systems. The investment climate remains uncertain; rules seem to change overnight and there is uncertainty about the future of the currency – the renminbi – currently pegged to the greenback.
China remains an attractive proposition – but it is not for the faint-hearted. The trouble is that the government’s attempt to graft a capitalist economy on to a country which remains a Communist dictatorship has created a system characterised by opacity and which leaves foreign investors unsure of what – exactly – they are buying. That is taking its toll on the stock exchange which, in turn, is making life very difficult for those Chinese companies who want to raise cash.
Whereas many of the world’s biggest stock markets flirted last week with multi-year highs, China’s exchanges are in a prolonged slump. Last week the Chinese authorities launched a dramatic attempt to revive its falling stock markets in Shanghai and Shenzhen. The amount that can be invested by foreigners is to be doubled. The measures were intended to give a huge boost to confidence in the stock markets. They failed.
For investors, Chinese shares have been a disaster. As far as foreign investors are concerned, China has become a land of profitless prosperity.
Paradoxically, an economy which has enjoyed strong growth and huge inflows of foreign investment has seen its stock markets fall by 17.4% this year to an eight-year low. Of China’s 15 largest listed companies measured by market capitalisation, the shares of only three are higher this weekend than they were two years ago. The rest have seen a dismal protracted drop in share price.
China’s largest listed company, for example, China Petroleum and Chemical Corporation, with a market capitalisation of $30.5bn, has seen its share price plummet from a two-year high of RMB5.97 in January 2004 to 3.60 now.
Last week’s roller-coaster ride helps demonstrate what is going wrong. Even last Monday, when the government put in place measures to boost the stock market, share prices actually fell. A report by the official Xinhua News Agency said China would expand the investment available to overseas investors to $6bn, compared with the current $4bn.
More importantly, Beijing announced there would be no new share offerings from the state sector, to allay fears that billions of shares from underperforming state companies would be dumped on the market.
Yet investors were not impressed, and the fear of a gigantic rights issue by the Chinese state, coupled with regulatory flip-flops, remains.
The banking sector badly needs access to foreign capital. China’s banks are mired in bad loans that could easily be worth $500bn and tainted by embezzlement scandals. The state has cracked down on bank loans to companies, and the poor performance of the country’s stock exchanges means firms cannot raise money there either.
As a result, many are turning to foreign stock markets instead. Earlier this year Bank of Communications, China’s fifth-largest lender and one of the better-run institutions, dropped plans to become the first Chinese company to list shares simultaneously in mainland China and Hong Kong and said it would initially go ahead with only the Hong Kong offering.
The move does not bode well for much larger simultaneous share offerings.
While Chinese stock markets have suffered, others are reaping the benefits. According to PricewaterhouseCoopers, Hong Kong’s stock exchange has been the most active in the greater China region in terms of initial public offerings (IPOs) of shares in recent years. Average deal sizes are also fast nearing levels of US listings.
In 2004, says PwC, Hong Kong accounted for 73% of the new funds raised in the Greater China region, while Shanghai accounted for 17%, Shenzhen 8% and Taiwan 2%.
But it is the performance of the economy that has most foreign investors puzzled. Hong Kong bankers joke that China is the only country in the world where annual gross domestic product growth is announced before December 31, and every province declares a growth rate above the national average.
In fact, many economists are convinced that the growth numbers are deliberately designed to smooth the peaks and troughs in growth.
Last year economic growth was officially 9.5%, against 9.3% in 2003. In the first quarter it allegedly grew by 9.4%; officials expect it to have expanded by between 9.1% and 9.3% in the first half.
Many analysts believe that Chinese growth in the mid-1990s was probably only half the official figures; last year it was almost certainly greater.
Some have started using alternative indicators to measure Chinese growth, including oil imports, nominal GDP (rather than the usual real GDP, adjusted for inflation) and the Baltic Dry index of shipping costs.
Economies in developing Asian countries tend to grow at the same rate as their demand for oil, argues Charles Dumas of Lombard Street Research. Chinese oil demand rose 15.6% in 2004, and Dumas believes growth could have been as high as 14%.
China may be a land of opportunities – but increasingly companies need the wisdom of Confucius to make them come to fruition.