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Whales and minnows

By China Economic Review

Plan to convert old British consulate rivals news that old state enterprise bosses have converted too

The Bund in Shanghai was the heart of the old Shanghai, and the fulcrum of Far East financing. When foreign firms were invited back to the city in the early 1990s, the government tried to get them to buy the majestic old banks and trading houses that had been seized from them, but there were few takers. HSBC famously declined an opportunity to buy back its domed headquarters at Number 12, the Bund. The pride of place along that stretch has always been the British consulate at the northern end, just opposite Garden Bridge. Set in broad grounds, the old building, dating from the 1850s, has been in a process of slow decay for more than half a century. The British government was allegedly invited to move back in at a price, but they turned the offer down, too.

Still, property is finally being resuscitated. A plan has been put together to turn the old consular grounds into a city club. The idea is that it would be called Waitanyuan, which translates as Bund Gardens. Perhaps one day this grand old building will experience again wafting cigar smoke and indelible claret stains. It is so to be hoped.

China Eye recently attended a private dinner at which were seated bureaucrats, state enterprises bosses and a couple of private company bosses. As the grain alcohol flowed, the private company bosses expounded with increasing vigor on the advantages and efficiencies of private enterprises and the reasons why state enterprises were fundamentally unable to match them. What was surprising was the reaction of the bureaucrats and the state enterprise bosses. They nodded, they agreed, they extrapolated.

For China Eye, it was a watershed moment. There was a time, as recently as 10 years ago, when Chinese officials would confidently state that state enterprises would always be the whales in the Chinese economic ocean, and private companies would never be allowed to grow much beyond the minnow stage. The Zhu Rongji approach in the late 1990s was only slightly modified from this, aimed as it was at beefing up and consolidating key state enterprise groups to make them strong enough to keep the private entrepreneurial tsunami at bay.

But the world has turned again, and if the dinner party repartee is anything to go by, even those inside the system are losing faith in its ability to survive in anything close to its current configuration. How long the transition takes depends on a million factors, but it will probably occur sooner than you would guess.

Change of some kind is required, and for proof one need look no farther than China’s stock markets, which are in dire straits for reasons that are crystal clear – low quality companies, low standards of transparency and corporate governance, and poor market regulation. To put it in a nutshell, there is a complete disconnect between the markets and the Chinese economy. The main market indicators hit new six-year lows in early February in spite of steady and strong economic growth over those six years. Meanwhile, Hong Kong’s stock market, now dominated by China-related companies, continues to do well. The difference: quality, transparency and regulation.

The indications are that China’s leaders increasingly accept that they cannot achieve a market turnaround without solving these basic problems. And without a market turnaround, however modest, the state cannot begin to divest itself of its huge holdings of state-owned shares (70% of the shares of China’s listed companies are still nontradable).

This huge overhang of potential liquidity needs to be dealt with sooner or later. The state needs the cash to fund its state welfare programs, and it needs to use the power of the markets – and the oversight of auditors and shareholders – to improve the efficiency of much of Chinese state industry.

Ordinary Chinese shareholders, burned and wary after years of losses, are very reluctant to fund this state withdrawal. But there is another source of cash waiting to come to the rescue – foreign investment funds. But Chinese authorities must open up the capital markets in a significant way to let these funds in – and the reluctant nostalgia freaks of the state enterprise world must resign themselves to greater transparency.

These things are happening. And indications are the rules for Qualified Foreign Institutional Investors (QFII) will be changed before too long to make better use of this underused channel – reducing capital requirements and the time foreign funds must hold Chinese stock before resale. There are also signs that companies which service this part of the financial sector are gearing up for an influx of foreign cash.

The problem with this scenario is that there are at present very few Chinese companies worth investing in from the perspective of, and to the standards of, international index-linked investment funds. But as the QFII channel opens wider and the proportion of foreign money in the China markets increases, the opportunity is there for any Chinese-listed company boss who wants to see his share price soar. All he has to do is clean up his books, add a couple of independent directors, make sure the company’s growth story makes sense and install a few competent managers to the organization chart.

The systemic psychological barrier to change looks like it was breached over dinner.

Hong Kong: Overpriced by half

Hong Kong’s property market and salary levels have perked up in recent months, which may make Hong Kong people feel more optimistic about life and the future. But it is to some degree illusory. Hong Kong will do well in the future to the extent that it competes effectively with the mainland cities in all ways, offering advantages and conveniences that Shanghai, Guangzhou and Beijing do not. But it has to be at reasonable prices. And after seven years of Hong Kong property prices and salaries getting real – i.e. more in line with mainland levels – the gap has started to grow again. Hong Kong has many advantages in its cooperation/competition with the mainland cities. It has a more reliable legal system, higher efficiency, more international experience, deep human resources in the financial sector, and a convertible currency. But it also has disadvantages, most notably the psychological gap between Hong Kong and mainland people, for the cause of which one has to look to the British colonial experience.

The solution to that problem is on the way, however. The biggest recent boost to Hong Kong’s economy has been the huge influx of mainland visitors over the past year, and as Hong Kong people interact more with mainlanders in their own backyard, hearing Mandarin on the street and in the subway, they are becoming integrated into the huge economy next door that is their future.

Integration would be smoother still, if Hong Kong property prices and salaries climbed down by half what they are today.

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