CHA CHING CHINA (PART 2)

19-Feb-2010 by Angus Walker


Where do you go to find information about this century’s greatest economic superpower? The CIA! Yes, America’s spooks have compiled all you need to know in terms of raw data about the country which is just smaller than the USA in terms of land, but has a much, much bigger population; 1.3 billion people and rising. The CIA’s assessment in shorthand: Make way, the new red kid is on the block - China!

For centuries China stood as a leading civilization, outpacing the rest of the world in the arts and sciences, but in the 19th and early 20th centuries, the country was beset with civil unrest, famines, military defeats, and foreign occupation. After World War II the Communists, under Mao Zedong, established an autocratic socialist system that, while ensuring China's sovereignty, imposed strict controls over everyday life and cost the lives of tens of millions of people. After 1978, his successor, Deng Xiaoping, and other leaders, focused on market-oriented economic development and, by 2000, output had quadrupled.  

For much of the population living standards have improved dramatically and the room for personal choice has expanded, yet political controls remain tight.

China's economy, during the last quarter of a century, has changed from a centrally planned system, largely closed to international trade, to a more market-oriented economy that has a rapidly growing private sector and is a major player in the global economy.  

Reforms started in the late 1970s with the phasing out of collectivized agriculture and expanded to include the gradual liberalization of prices, fiscal decentralization, increased autonomy for state enterprises, the foundation of a diversified banking system, the development of stock markets, the rapid growth of the non-state sector, and the opening to foreign trade and investment.  

China has, generally, implemented reforms in a gradualist, piecemeal fashion, including the sale of minority shares in four of its largest state banks to foreign investors, refinements in foreign exchange and bond markets. After keeping its currency tightly linked to the US dollar for years China, in July 2005, revalued its currency by 2.1% against the US dollar and moved to an exchange rate system that references a basket of currencies.  

Annual inflows of foreign, direct investment in 2007 rose to $75 billion. By the end of 2007, more than 5,000 domestic Chinese enterprises had established direct investments in 172 countries and regions around the world.

Interested? Thinking of taking the slow boat to China to get a slice of the action? Well, look at it from an outside investor’s point of view first. Chinese stocks aren't available - at least not to you. China's domestic stock markets in Shanghai and Shenzhen feature two classes of stock: "A-Shares" which are denominated in yuan and, until recently, could be owned only by Chinese citizens and "B-Shares" which are denominated in dollars and can be owned by foreigners.  

With an account at a global brokerage firm, like Merrill Lynch, you might be able to buy some "B-shares," but, in the tradition of Groucho Marx and all clubs willing to have him as a member, you probably wouldn't want to own any (the "B-Share" market is rumoured to include the sorriest lot of public companies on the far side of the Pacific). So how do you buy "A-Shares"?

Well, if you happen to be a bank, fund, or brokerage firm with $10 billion in assets, a multiyear track record, and the willingness to commit at least $50 million, you may be able to eligible as a Qualified Foreign Institutional Investor, which will allow you to buy up to 10 percent of the outstanding stock in any listed company (provided you and other QFIIs don't own a total of more than 20 percent—China is not about to let foreigners abscond with its crown jewels).  

If you're short of $10 billion, then you may be able to strike a deal with an established QFII like UBS, in which the QFII buys the stocks you want, then sells you a "swap" that passes some of the profits and losses through to you ("some" because the QFII won't do this out of the goodness of its heart). Of course, to make this worth the QFII's while, you'll still need to commit a few million.

So, forget about A-shares. Instead, turn your attention to the Hong Kong and New York Stock Markets. Chinese companies can sell stock in Hong Kong (known as, respectively, "H-Shares" and "Red chips," depending on whether the companies are incorporated in China or just have assets there). The Chinese government controls most of these companies, but they tend to be, as one hedge-fund manager put it, "real companies" (as opposed to some of the horrors listed in Shanghai and Shenzhen).

Make no mistake, there’s money to be made, and business to be done, but on Chinese terms. Accept those and you’ll be on a fast track to a future that leaves the slow boats in its wake.