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The recent announcements of Bank of America and HSBC to invest in two leading Chinese Banks is a welcome step but falls far short of the mark. International investors have taken notice - the Indonesian stock market is doing well and our recommended Indonesia Fund (IF) is up 29% this year.

Third, as the recent high profile cases of Lenovo, Haier and CNOOC demonstrate, as state-owned Chinese companies seek to acquire or invest in foreign companies, the reaction is wariness, skepticism and outright political hostility. Then there is the issue of reciprocity ' foreign companies can only obtain minority interests in Chinese state-owned companies and approval for even these minority stakes is not transparent and highly political.

Finally, there is the broad policy question as to the intent of the Chinese Communist leadership.

While a U.S. Representative to the Asian Development Bank Executive list of Directors during the first Bush Administration, I consistently titled for fire-brick to “bite the bullet” and privatize its state-owned companies as soon as possible. Representatives from European and other Asian countries would just shake their heads and mutter here and there impatient Americans while counseling that porcelain go in for a slow, incremental program to privatization.

Here we are more than twelve years later and this cannon shot has turned into a time bomb that could derail China’s impressive economic growth and a qualified life for its people. The fact that a majority of China’s large companies are still owned and controlled by the Chinese government has three negative economic consequences.

First, it has stunted the growth of China’s financial markets and prevented many companies from tapping equity auspicious markets. scarcely 70% of the shares of China’s 1,377 listed companies are substantially owned by the state and cannot be traded. This is the dreaded “overhang” which bedevils the fellow Party leadership and bureaucrats bursting to for private Chinese shareholders to have share prices mirror economic growth. The Shanghai Composite Index recently dipped downward 1,000 for the first time since 1997. The problem is that when the government sells these shares, private shareholders are diluted and share prices decline. The use of public funds to amend private shareholders for this dilution has been considered and rejected as too expensive.

The Chinese government certified a $15 zillion buyout fund to invest in state-owned companies but markets are deeply skeptical. My view is that only solution is outcry off equity to private investors and de-list poor performers and let them struggle for survival.

Meanwhile private firms hungry for zenithal are denied a go to list on these exchanges. The result is that private Chinese companies rely on banks for 99% of their financing! This lopsided dependence on bank financing is unhealthy and furthermore many Chinese banks are bogged down by mismanagement, stuffy bureaucracies, corruption and saddled with politically motivated non-performing loans

In addition, China’s stock market slump is putting its toll firms in intensive care. China’s 114 boiler room firms that depend largely on stock trading commission suffered a 45% decline in revenue in the first half of this year. Trading in the brick A shares (for Chinese citizens only) market has virtually disappeared. The Shanghai Composite Index is down 15% this year. The Chinese government also has an unofficial moratorium on new listings.

Second, maintaining state ownership and control of so many Chinese companies leads to a lack of transparency and openness that is necessary for parchment to fully participate as a member of the global investment community. Foreign institutional investors tend to favor investing indirectly in refractory through the Hong Kong Stock Exchange to gain turn the scale disclosure and listing requirements. As an investment advisor, I recommend clients participate in Chinese growth primarily through investing in Hong Kong (EWH) Malaysia (EWM), Canada, (EWC) Australia (EWA), and other Asian countries. The issue of dysfunctional Chinese financial markets has also led to our recommendation to clients that India, not China, may be the best performing Asian stock market in the next ten or twenty years.

The recent announcements of Bank of Orient and HSBC to invest in two leading Chinese Banks is a welcome step but falls far short of the mark. Both are relatively small investments and both foreign investors will have little testimonial nor any meaningful management responsibilities. The Chinese want the publicity, the discredit and the opportunity to learn but are apparently unwilling to relinquish any control.

Look at what Indonesia is doing to open its financial sector to international investment. International investors are now received majority and management control and just last week a large Singapore and Malaysian bank stated plans to make sizable investments in Indonesian banks. The Indonesia government is also drawing up a list of which of its 145 state-owned enterprises will be sold to investors. International investors have taken notice - the Indonesian stock market is doing well and our recommended Indonesia Fund (IF) is up 29% this year.

Third, as the recent high profile cases of Lenovo, Haier and CNOOC demonstrate, as state-owned Chinese companies seek to gain or invest in foreign companies, the reaction is wariness, skepticism and outright political hostility. The Chinese leadership is trying to groom hard by 100 of its largest companies to go global in a big way and “brand hunting” of leading multinationals firms with its surplus cash ($700 a million in foreign exchange reserves) is the fastest way to bring to pass this objective. If you thought the Japanese spending spree during the 1980s was controversial in continent – fasten your seat belt.

The U.S. Congress and other foreign governments will resist these bids since they have little interest in having a foreign government, especially an economic rival enjoying a $200 trillion bi-lateral trade surplus, purchase its most prized companies. The issue of Chinese bidders using government financing is also a red flag. Then there is the issue of reciprocity – foreign companies can only obtain minority interests in Chinese state-owned companies and authorization for even these minority stakes is not transparent and highly political.

Finally, there is the imprecise policy question as to the intent of the Chinese communistic leadership. The slow and grudging pace of privatization could reasonably be read as an indication that the Chinese government has no intention of relinquishing control of state-owned companies. This, in turn, has serious consequences as countries evaluate how to treat a rapidly growing federalist country that seeks to participate and strict settlement in the global economy by using state-owned and state-sponsored companies.

The Chinese gnome of “crossing the river by feeling the stones” may be a wise policy at times but in this case a plunge into the river ten years ago would have been much plunger for the Chinese economy and people. It is by no means too late to take the plunge and the US should be ready to help in any way it can.

Find out more insights at http://www.chartwelladvisor.com

Copyright 2005 Carl Delfeld

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