Saruhan Hatipoglu sshatipoglu@beri.com

CHINA'S GRADUAL BUT STEADY MARCH:

Strong Signals for Major Changes 

An Encouraging Move    BERI S.A. had predicted that the new year would start with positive news for foreign investors considering China.  Aware of the weaknesses in the country's capital markets, the government decided in January to facilitate foreign capital flows into the domestically-traded companies.  In 2005, there was planning to make the capital markets more attractive.  Before reform measures took place last year, the government owned over 65% of total market capitalization, which resulted in an inefficient market.  However, the January decision became the first basic step in making the capital markets liquid.  According to the decision, any domestic company that had successfully completed the share-reform program would be eligible to offer shares to foreign companies.  As of February, foreign investors will be able to buy existing or newly issued shares by traded companies.  The buyer will have to purchase at least 10% of the company-of-interest and hold those shares for a minimum of three years. Share reform will complement China's earlier reform measure, commonly known as the Qualified Foreign Institutional Investors (QFII) program, which makes available to certain foreign buyers Class A shares and bonds.  The government had raised the limit on this program from US$4 billion to US$10 billion in 2005.  These reform measures will not only bring in more capital into the country, but they will also enhance the confidence of foreign companies across a broad swath of industries, particularly in banking and finance.        

Newbridge's Shenzhen Is CitiGroup's Guangdong    When Newbridge Capital Inc. acquired 17.89% of the Shenzhen Development Bank and became its largest shareholder, many analysts welcomed the purchase as the beginning of a new era in China's financial services.  The purchase was indeed a significant landmark for China, but it was only the beginning of a series of dramatic changes that would inevitably shape the country's banking and financial system.  In January 2006, CitiGroup submitted a US$3 billion offer for 85% of available shares in the Guangdong Development Bank (a consortium offer).  If accepted by regulatory officials, this will give over 40% of bank ownership to the CitiGroup, but this offer could be accepted only if China's regulation not allowing over 20% ownership of a domestic company by a single foreign investor was modified.  The deal will most likely be approved, eliminating the restriction by a wide margin.  Even if the deal is not sanctioned (which is low probability), there will be major changes in China this year that will bypass this artificial limit. 

There is substantial foreign interest in China's banking institutions, and these banks are burdened with a high level of nonperforming loans and other types of operating problems.  It is precisely this combination that will motivate regulators to make significant modifications to their existing laws guiding foreign investment in the financial market.  Expect increasing activity throughout the year.  In addition, China's judicial system will also contribute to the growing confidence of overseas investors.  In the first days of January, a Shanghai court ruled that Starbucks' trademark rights and branding privileges were violated by a local Chinese company that translated the company's name into Chinese and used a very similar logo.  In a country where respect for intellectual property has been almost nonexistent for years, this decision is a strong signal that significant changes are on the horizon.        

Conclusion    China will present great opportunities for foreign investors in 2006 and the coming years.  This forecast is built on already-strong foreign attitudes about the earnings potential in China.  A recent A.T. Kearney study revealed that China maintained its top position as the most attractive foreign direct investment (FDI) location in the world last year.  Almost 45% of survey participants (among the Global 1000 firms) showed greater confidence in that country than in 2004. "Foreign corporate investment has been critical to the development of the China's manufacturing base. Now the Chinese government seeks to replicate that same success by leveraging FDI to modernize the country's financial system" said Jonathan White, manager of the FDI Confidence Index. " Financial service investors see vast opportunities in China---from retail banking for its increasingly wealthy middle-income population to underwriting for emerging private sector-oriented Chinese companies.  These factors, along with WTO-mandated liberalization of the financial sector by the end of 2006, are leading the world's financial giants to foray into China. In 2005, the China Construction Bank received a US$3 billion commitment from Bank of America and its initial public offering in Hong Kong generated over US$8 billion- the largest IPO in four years," said White. The already-strong existence of large foreign corporations through FDI commitments, the rising pace of offshoring (particularly in manufacturing, technical services, and R&D) and China's regulatory and judicial reform measures will only accelerate investment activity.  2006 is the Year of the Dog according to the Chinese calendar.  Josh Billings once said that money would buy a good dog but not the wag of its tail.  In China, 2006 might just offer a dog that comes with the wagging tail. 

DIRECTOR'S PERSPECTIVE Last Updated 9 January 2006