Dangers Accompany China's Allure
November 16, 2003
The temptresses of Wall Street are peddling Chinese stocks these days - and maybe that's why we should think twice before we make that long march into the unknown.
To be sure, many so-called "emerging markets" have delivered boffo returns this year. Shares from Eastern Europe and Latin America have advanced more than 50 percent from early January through late October.
But no nation appears to have captured Wall Street's imagination like China. The China Fund (ticker symbol: CHN), a mutual fund that trades like a stock, has shot up about 160 percent in 2003, a product of hype and hope.
There's talk that China has a $100 billion trade surplus with the United States. There's talk that China plans to import about $2 billion worth of cars and trucks from General Motors and Ford Motor Co.
There's talk that China's rapid economic growth has single-handedly pushed up the prices of key commodities, including oil, timber and copper. There's talk that China will have the largest economy in the world by 2050.
All this talk has fallen on open ears. Investors in 2003 have poured $345 million into Chinese stocks, according to EmergingPortfolio.com, a stock market tracking company based in Cambridge, Mass.
Some investors might reap rich rewards in China. But many could harvest regret. And some of today's dreamy-eyed investors could wake up and see a darker side of China: a nation with weak banks, few rights for property holders, no laws protecting creditors, no internationally recognized standards for accounting - and no free press to spotlight all that can go wrong
Weak banks. Chinese banks could be victims of a catastrophic Catch-22.
They cannot grow unless they lend money. Yet they cannot come up with money to lend unless longstanding debtors pay them back; the state-owned banks do not have sufficient reserves upon which to finance future loans.
"As China continues its reform of the financial sector, the health of state banks remains a central concern," noted a recent report from Moody's Corp., a credit analysis firm based in New York.
Based on what little analysts know, Chinese banks held $170 billion in problem loans in 1999. They could hold as much as $500 billion in problem loans today, in an economy with a 2002 gross domestic product of $1.1 trillion (about one-ninth the size of the United States). This could mean that as much as one-half of China's annual output could be tied up in loans that have yet to be repaid - and might not ever be repaid.
"There is a very real risk that China's substantial rates of growth have been financed with shaky credit," said Geoffrey Dennis, an emerging markets analyst with Smith Barney.
Uncollected debts. Lending in China is especially risky because there is no legal recourse to collect debts.
There are no foreclosure procedures. There is no way to find out (countrywide databases have yet to be developed) whether a borrower has walked away from a previous loan; there is no Fair Isaac credit scoring. And there is no way to penalize a borrower for having a lousy track record for repaying debts.
"It's extremely primitive. The only way to collect is through so-called second- or third-party channels," said David Gamble, president of Emerging Market Strategies Co. in Providence, a company that specializes in analyzing legal risk in emerging markets.
Debt-collection channels, Gamble said, are through the Communist Party or outside the law. "It's uneven, unpredictable and not widely effective," Gamble said.
Property rights. Safeguards for private property are just as dicey: What you own today can be easily seized by the Chinese Communist Party tomorrow.
How?
Picture the following hypothetical example.
A company opens for business in China. That company draws foreign investment. That company wields enormous economic clout. That economic clout soon translates into political clout. Sensing a threat to their power, Communist Party members arrest the company's founder on trumped-up charges.
Some fear that a similar scenario recently played itself out in Russia. Mikhail Khodorkovsky, the chief executive of Yukos (a large oil company), was recently arrested on seven counts of tax evasion and embezzlement. Following the news, the Russian stock market lost 10 percent of its value in one day.
"Everybody's paying close attention to this story in Russia because, realistically, it could happen in a lot of countries," including China, Dennis said.
Final thoughts. Despite all that can and might go wrong, China could still make a great leap forward.
Just be careful.
After the recent rise in Shanghai stock prices, "China is no longer a ground-floor opportunity," Dennis said.
Gamble seconded that notion.
"Some people will make a lot of money to be made in China," Gamble said.
But during the next 20 years, investors could lose a fortune and make a fortune over several boom-bust cycles, he said.
ctnow.com |
