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Wrong turn seen in China's economic
roadmap
By Jayanthi Iyengar
NEW DELHI - Until now, the Chinese have won
nothing but accolades for their economic performance.
This is partially because of the manner in which they
have opened up, permitting only foreign direct
investment (FDI), while insulating the economy from
global instability by curbing short-term foreign
portfolio investment flows.
Thus, during the two
decades of liberalization, the Chinese have been able to
attract more than US$300 billion in FDI, nearly double
what the Association of Southeast Asian Nations (ASEAN)
region has been able to manage during the same period.
Yet, when it comes to foreign portfolio investments, the
Chinese have followed a closed-door policy, thereby
protecting their economy from every ill wind that blows
on Wall Street.
The Indian experience has been
different. Opening the economy up to foreign portfolio
investments preceded FDI opening. The opening up of the
Indian capital markets to foreign institutional
investors (FIIs) has also been faster than
liberalization of FDI. However, the implications of this
took several years to sink in. Thus, after a peak
economic performance in 1995-96, Indian policymakers
thought there would be no looking back. Industrial
growth had touched an all-time high of 13 percent.
Exports were up 20.3 percent as compared with the
previous year. Gross domestic product (GDP) growth
seemed to have stabilized at 7.3 percent, the same as
the previous year. India had everything going for it -
or so it seemed until the unexpected happened.
The booming Asian Tigers collapsed. The world
markets took a tumble. India's Bombay Stock Market (BSE)
sensitive index (Sensex) moved in synch with the Hang
Sang and Nikkei, and between April 30 and December 1996,
the Indian stock markets lost more than $40 billion in
market capitalization.
The risk premium on
investing in Asia quadrupled. Fund managers reduced
allocations to Asia. India itself had been saved from
the worst of the "contagion effect", as it had opened up
only partially on capital accounts. Yet foreign
investors shunned India along with the rest of Asia.
India Inc's investment plans went awry because of the
depressed global sentiments. India's projected growth
targets for 1996-97 were shot down. The GDP growth
during the year was still a robust 7.8 percent, but
within a span of just 12 months, industrial growth had
halved to 6.1 percent, and export growth was one-fourth
the level notched in the previous year at 5.6 percent.
Indian policymakers were initially at a loss to
explain how the magic that had worked just a year
previously had failed to do so in 1996-97, but the Asian
meltdown taught India and its 20 million investors
holding a market capitalization of $300 million the true
meaning of globalization and market integration.
The Asian meltdown led to a new coinage. It was
first used by India's then finance minister Yashwant
Sinha, who started talking of tailoring policy measures
to bring back the "feel-good factor". His statements
were followed up by industry and others, all of whom
wanted to turn around the economy on the shoulders of
"sentiment".
Since then, there have been several
market setbacks. In February 2000, India's prime
information-technology (IT) stock, Infosys Technologies,
listed on multiple markets, was quoting about Rs10,000
($206) per share in India. The Sensex had peaked at
6,200 points. The joke doing the rounds in the
"optimistic" trading circles was that one needed to just
"play" in Infosys stock to become a millionaire - when
the unexpected happened.
The IT boom turned into
a doom. The bloodbath on Wall Street reduced many
millionaires into paupers overnight. The Sensex tumbled
from its all-time high, never to span those
unprecedented heights again. Since then, there have been
the accounting scams, September 11, 2001, and now the
Iraq war. At each of these junctures, India's two
indices, the Nifty and Sensex, have yo-yoed in synch
with the New York Stock Exchange (NYSE) and Nasdaq.
The Chinese are opening up their markets at a
similar juncture. They first announced some measures for
qualified institutional investors (QFIIs) in November
and followed these up with fresh announcements in March,
oblivious of "Operation Shock and Awe" wreaking havoc on
Iraq. And while the proper implementation of some of the
announced measures is expected to take a little time,
China's decision for "marketization" seems to have been
ill-timed. It is opening its markets not on a cyclical
upswing but on a downward path, ushered in no doubt by
what now seems to be a prolonged war.
There are
two main reasons China is going ahead with its capital
market reforms at this juncture. At one level, it is
under pressure from the World Trade Organization (WTO)
to open up its markets and step up its reforms process.
At another, Chinese companies are now beginning to look
outward.
According to the World Investment
Report 2002, firms from China have been expanding abroad
rapidly. As of last year, the top 12 Chinese
transnational companies (TNCs), mainly state-owned
enterprises (SOEs), controlled more than $30 billion in
foreign assets. This is close to the entire outward
stock of Latin America in the mid-1990s. These Chinese
companies now have more than 20,000 foreign employees
working with them and hold more than $33 billion in
foreign sales. Non-SOEs are beginning to follow the SOEs
abroad, although most of them are small and medium-sized
TNCs. Such TNCs have investments in more than 40
countries, including countries outside of Asia.
From a purely market-integration point of view,
many of these companies would soon start seeking listing
on foreign stock markets. The fallout of such a
development would be the completion of the circuit, with
foreigners investing in China as well as mopping up the
Chinese free float in the international markets.
Such two-way integration, create room for
arbitration opportunities, brought on by exchange-rate
differentials and imperfections between markets, which
do not permit the stabilization of stock values across
markets. And it is such arbitration opportunities that
foreign portfolio investors seek when they look for the
means to make a market killing.
It is
significant that once the market integration process is
complete, the Chinese government will find it difficult
to drive sentiment with its positive communications on
happenings in China. Instead, it will be the foreign
investors and market movements that will be setting the
tone for investments. Consequently, the dollars will
flow in when the Chinese need them least - as happened
with India in the postwar period - and they will move
out when they are needed the most.
That the
Chinese are gearing up to tackle some of these problems
is clear from statements by Chinese policymakers in
recent weeks. Speaking at the 10+3 (ASEAN plus China,
Japan and South Korea) High Level Seminar on the
Management of Short-Term Capital Flow and Capital
Account Liberalization in Beijing over the weekend, Dai
Xianglong, governor of the People's Bank of China,
conceded that international capital flow had provided
financial markets with greater liquidity. It had also
optimized the global allocation of capital by filling in
financing gaps, promoting economic growth and
well-being, and improving the balance of payments (BOP)
position of the recipient countries. Yet, if not
supervised effectively, international capital flows,
especially short-term speculative flows, could have a
negative impact on the BOP, on financial markets, on
economic performance and even on social stability in the
host country, Dai said.
In December 1996, China
introduced current account convertibility and began to
work toward capital account liberalization on a
step-by-step basis, subject to certain parameters. It
resolved that it would encourage foreign direct
investment, strictly control foreign debt and work
toward centralized administration of foreign debt. It
would also cautiously liberalize foreign portfolio
investments to avoid associated shocks and develop a
market-based, managed floating-exchange-rate regime.
The first step on this roadmap to
"marketization" of the Chinese capital markets began
last November when the country opened up investments in
its A-group shares to foreign investors. Until then,
foreign investors were permitted to invest in B-group
shares, but the volumes in this group of shares do not
influence the index. Hence, though foreign investors
could invest in the shares of select Chinese companies,
the markets were still shielded from informed investors'
sentiment, as well as discovering stock values through
the market mechanism.
It is significant that
last November's decision to open up the Chinese capital
markets to QFIIs was welcomed by a fall in the indices
at the Shanghai and Shenzen. This was despite the fact
that investment experts such as Goldman Sachs had
forecast that unlike FDI, the liberalization on foreign
portfolio investments would yield the Chinese not more
that $3 billion to $5 billion annually, or as little as
1 percent of China's market capitalization of $300
billion.
As in most closed economies, the value of
Chinese stock has until now been determined by political
patronage rather than market mechanism. The entry of the
large foreign portfolio investors with deep pockets is
expected to correct price anomalies, in a manner that
may disfavor Chinese companies.
While the first
step to capital equity market liberalization was taken
in November, China followed it up with the announcement
this month that it was opening up its capital markets
not only to QFIIs but also to government-managed trusts.
Though the finer details of the scheme are still being
worked out, reports coming from China seem to suggest
that the government-managed trusts would be similar to
the Singapore government's trust, but the big pension
fund would remain excluded.
In all
well-developed markets, pension funds are the prime
movers and shakers. Though their entry is being debarred
at this point, it is only a matter of months before this
last barrier to total market integration falls, and the
Chinese become as vulnerable to the mood swings on NYSE
and Nikkei, as are the Indians.
(©2003 Asia
Times Online Co, Ltd. All rights reserved. Please
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