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Brief introduction to China risks

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Continuing from part 2, The merger of Inability to distill, Not invented here, and Competitive bad advice:

Before turning to a brief introduction to China risk, space limitations in the previous post required that I defer the operational component.

Operational, in-country side of the commercial client:

1. These people are close to the problem and bear the pain

They are often the wariest depending upon their corporate structure and whether true P&L responsibility resides at this operational level. A reasonable indicator of local control would be a local partnership or other tax effort that limits US asset consolidation.

2. They feel risk keenly in all aspects of the business

While this is true, situations vary as to whether it is more effective to approach the financial/risk group or the operations group -- even if on-the-ground people have contracting authority. Working with operational units can be daunting if the financial/risk group is in denial (see part 1) as any counter-corporate views quoted by local operators, and sourced back to us, complicate our ability to support the client.

It is possible that a country manager would proceed on the basis of protecting his or her operational P&L unit. A historical problem has been the deafness showered on country managers by headquarters and so deprives them of engagement authority. If the parent is genuinely international in its mindset of keeping the global supply chain flowing -- candidates such as Delphi, Intel, HP, and possibly Motorola come to mind -- then the country manager might have significant local authority to protect assets.

While we are often asked for checklists for China, I will go a bit father and generalize a starting list that can begin to identify risk, but is not enough to quantify it:

Overall take on China risks:

The People's Liberation Army (PLA) runs an extraordinarily large portion of the economy through a network of overt and covert subsidiaries -- and the overt sides openly maintain defense and commercial units open to dual-use exploitation. The PLA's ten State Owned Enterprises (SOE's) constitute the "world's biggest business empire."

The CCP (Chinese Communist Party) tries to keep it organized, but we think that it is losing the struggle, even as sustained economic growth remains the litmus test of Communist Party legitimacy and control. (It is striking to see how many suggestions that we see of China reverting to a regional warlord model.)

It is a rough and tumble world not for the faint-hearted:

  • Growth overshadows social justice (Profits with no accountability in government)
  • Labor buyer's market (Sweatshop labor for domestic and export production)
  • Right to strike removed in 1982 (Without collective bargaining, workers will rely on petitioning government, lawsuits, and violence)
  • Property rights recognized in 2004 ('Capitalists' and 'entrepreneurs' legitimized within the CCP)

The investment risks are too great to do justice in this short space but here are some of the leaders:

  • Gross fixed investment is driving economic growth
  • Current economic growth is "not sustainable"
  • Uncertainty over severity of cooling measures
  • Conventional monetary-policy tools not predictable
  • Banking system has huge overhang of bad loans and corruption

To be continued, part 4

Gordon Housworth



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