China

Bailing out western economies

With the Chinese economy booming staggeringly and investments flowing out to foreign destinations, a big concern for the authorities is the education of investors, comments David Watts

  As the western world heads into an uncertain economic future China has been bailing out particularly troubled American banks.
First there was the $3 billion stake in the venture capital company Blackstone. And then the same bank, China Investment Corporation (CIC), paid $5 billion for a 9.9 per cent slice of Morgan Stanley. In the first such venture in Europe, China Development Bank bought a 3.1 per cent stake in Barclays Bank in Britain.
   The momentous nature of this change, with a notionally communist country bailing out or buying into the world’s leading capitalist economy, seems to have gone almost unremarked. What would Chairman Mao have made of it?
   It is only a short time since any kind of Chinese investment in the United States, or even in Europe, would have aroused suspicion. Yet here we have some of the tottering citadels of western wealth being given injections of cash by the newest member of the capitalist club. The phenomenon of state capitalism has come of age much faster on the international stage than anybody could have predicted.
   But Chinese banks are not merely taking advantage of a particular weakness in the American economy. The movement of money into New York is part of an overall flow of Chinese capital which, for the first time, was greater over 2007 than inward investment into the country. And if some of the investments appear a little unwise at first blush that is because an out-and-out profit is not always the main motivation — the investments are a learning curve not only for the political and economic leadership in China, they are also seen as an opportunity for younger financial experts to get to know the more esoteric secrets of western financial instruments.
   Chinese cash is fuelling investments across the globe from energy projects in Central Asia to the Middle East, Africa and Latin America.
The need for foreign destinations for Chinese money becomes apparent through the staggering statistics of one of the world’s fastest growing economies: last year’s trade surplus was a record $245 billion; and China’s foreign exchange reserves rose by $462 billion to $1530 billion. And with $200 billion in CIC’s war chest this is clearly just the beginning of the greater availability of Chinese capital on the world scene. CIC says that about a third of its investment cash will go abroad.
But how will the Chinese interact with the rest of a world economy feeling the icy winds of nascent recession?
   Already demand for Chinese goods in the United States is slackening; but what is the broader picture? The Chinese banking and financial system is so new on the world scene and does its business in such secrecy that few outside China really know how it functions and what are its strengths and weaknesses.
   Given the level of exposure of western economies to the current uncertainties the relative lack of sophistication of the Chinese banking system has turned out to be a boon. There are no exotic derivative products which for western bankers are a burden. Unlike their western counterparts few Chinese banks have any substantial dollar investments. Their key revenue earner is still the interest margin they earn on loans. Also, unlike western banks the Chinese system has tremendous liquidity. It is estimated that it has some $5.2 trillion in deposits or 160 per cent of the country’s GDP (gross domestic product). That healthy position is perhaps the best indicator of how relatively unsophisticated are its customers, given the reputation for financial acumen that they enjoy, with lending rates having gone up six times in the last year while the interest the banked pay savers on as much as 50 per cent of the accounts is only 72 basis points. With margins for Chinese banks expanding their customers are virtually giving them money for nothing. It is hard to imagine western consumers putting up with such a deal but then this is an economy run with command aspects still in place.
  

  But it is in that command mind-set that the greatest change is taking place. The most exciting focal points are around mortgages and credit cards, neither of which existed in China ten years ago. Here growth has been extremely rapid, backed up by a booming domestic economy and by the reality that Chinese banks have not been exposed to the sub-prime blight, which is so damaging those in America and Britain.
   On the international front the customers are driving change as the traditional hard core of Chinese banking, the large corporates, expand overseas and need banking services to go with that expansion. Many Chinese banks do not have global platforms and they need to globalise quickly so as not to lose customers. ‘In the next five years the biggest story in Chinese banking is going to be globalisation’, according to Jing Ulrich, chairman of China Equities at JP Morgan in Hong Kong.
   Just as Chinese firms are moving out into the world there is going to be a concomitant interest in foreign firms investing in China just as they sought to do in the booming Japanese economy of more than twenty years ago. But it will be a gradual process and the Chinese will once again use the Hong Kong gateway. The first step for a foreign company is to list in the former British territory as a ‘red chip’ company. Red chips are incorporated in Hong Kong rather than on the mainland, even though all their business comes from China. It is expected that the first ‘red chips’ will be listed this year and the first foreign listings in Shanghai will follow in 2009 or 2010. The Chinese expect that the foreign listings will boost the quality of a local market which is still very young, having been in business for only about  15 years. Here again China has been fortunate in having so far remained protected from what is happening in global financial markets by the isolation from them of its markets in Shanghai and Shenzhen. Since foreign holdings in the mainland markets are extremely limited there has been no effect of foreigners selling off their shares. Hong Kong, much more integrated into world markets, has suffered some of those markets’ reversals as a result.
   A concern for the Chinese authorities is the education of investors, both those investing on the domestic market and corporates investing abroad. At home there is a tendency for investors to treat the market like a gambling den. The punters need to be reminded constantly that stock values can go down as well as up and it is inadvisable to bet their homes on the market. For the Chinese investing abroad the government has set up the Qualified Direct Institutional Investor programme, which educates potential investors in how to behave in foreign markets. Since it is predicted that some $90 billion will be flowing out of China into foreign investments over the next year this is clearly going to be an important element in the process. It started taking off in the second half of last year and has been slow so far but is expected to accelerate over the year. It is seen as complementary to the Qualified Direct Investment programme, which has enabled investment by individuals in the Hong Kong market with professional help for some time.
   Chinese planners are confident that the effect of the slowdown in the world economy on their economy will be much less than in the rest of the world. The economy has been growing at some 11 per cent a year, which is expected to slow to 9.9 per cent in 2008 while inflation is expected to increase slightly to 4 per cent.
   Here again the Chinese economy enjoys an advantage over its western competitors. And such is the strength of the boom at home that it is likely to be immune from any drastic fall-off over the next year. Even if things turn out not quite so well the government is in such a strong fiscal position that it can always mobilise its resources to invest in infrastructure and domestic consumption to keep the economy racing along.

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