To offer a brief history lesson, before 1978, the majority China's GDP came from its state-owned enterprises. These companies were big, inefficient (quota rather than profit driven), corrupt, communist manifestations that were funded by the central bank (as one would expect for a controlled economy). After Mao died, China set on a slow and deliberate change from a planned to a market economy. They mostly have Deng Xiaopeng to thank, although Zhao Ziyang officially kicked things off. China designed a very clever "dual track system" (shuangguizhi) to ween companies off of planned economics piecemeal. If you're interested in how this worked, email me, but the explination is too long for this post. After this policy was implemented, the previously monopolistic SOEs started to beat up by the new market competition. Because they were losing money, the SOEs decided paid off less and less of their bank debt, and instead, because of remnant bureaucratic inefficiencies, piled on more debt to finance their operations. As a result, the debt/equity ratio ballooned from 12% in 1978, when policy change began, to 211% in the early 90s. China ended up stepping in and infusing these insolvent banks with cash.
With this history lesson, I found it interesting to read today a McKinsey Quarterly report entitled "Global Investment Strategies for China's Financial Institutions," which had a lot to say about far financial institutions in China had come. As the report put it:
The shift from investment target to investor came suddenly and many Chinese institutions are not fully prepared for their new role. Not long ago, state-owned Chinese banks were saddled with nonperforming loans, which effectively blocked their global aspirations. But the level of bad loans has dropped rapidly—from about 30 percent of total loans in 2001 to 7 percent in 2007, according to official figures...Why is this important? Well, this global credit crisis is creating great investment opportunities for cash-flush companies like China's financial institutions. McKinsey also notes that these purchases will do much to also bring in needed expertise, particularily in areas such as risk management, IT, product development, and customer service.
What I found most interesting about this report was in the suggestions McKinsey had for these banks' strategy. They are currently looking at investment opportunities on a case-by-case basis, without enough regard towards a larger strategy. As McKinsey puts it: "Chinese managers [should] consider how many deals they want to complete in the medium term, what type, and in what markets. They should also think about how deals can add value not only in a portfolio but also independently. With a better game plan, they can weigh opportunities against their longer-term goals and become much less reactive." If you have been reading this blog religiously, you may be wondering how this relates to US anxiety over the security ramifications of foreign SWFs strategically investing in different companies.]Well, these are just banks, not sovereign wealth funds, and therefore do not carry the same type of political tension, because they cannot possibly have any "devious political motives," as some hawks might suggest SWFs have.
The report goes on to suggest that China looks beyond mere portfolio returns when choosing deals. Buying minority stakes in companies across the world would allow access to many companies' inner workings via seats on the BOD. Through these investments, China can have access to important management and human capital opportunities - including hiring one of us to go out there one day...
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