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The Middle Kingdom's economic might.

Economic fundamentals and an irreversible trend toward opening up to the outside world make it clear that China is in the front rank for investment interests.

For many hundreds of years, China has been a magnet for Westerners fascinated by its size and culture and drawn toward its commercial opportunities. In the Chinese language, the word "China" literally means "The Middle Kingdom" or, alternately, "The Center of the Universe." In the ancient days, foreigners would come to China to pay homage to The Middle Kingdom.

But the collision of imagination with Chinese reality has tended to result in pendulum-like swings of the American perception of China between admiration and deep concern. This phenomenon was most recently manifested in the flood of goodwill and business interest in the reform decade of 1979-1988 that twice made Chinese paramount leader Deng Xiaoping Time magazine's "Man of the Year," which was followed after the Tiananmen incident of June 1989 by a shift in many quarters to a view of China as a pariah.

I can say, after studying the Chinese language since age 10 and having lived and worked in China for the past 14 years - before the "Open Door Policy" began - that it is difficult to avoid being swept up in the mood of the moment. But I believe that certain facts and trends are enduring.

The economy will continue to grow rapidly. Since 1978, China's GNP has grown at an average of about 8% per year. But per-capita GNP is still only about $370, and the hunger of the Chinese people for a better life provides an irresistible force for future growth.

The process of opening to the outside world, absent a sea change in the attitude of developed countries toward China, is irreversible. China's foreign trade has grown from a mere $20 billion in 1978 to $135 billion in 1991 and now accounts for 25% to 30% of the country's GNP. Entire regions of China, in particular the coastal provinces, would fall into depression without foreign trade. China recognizes this, and actions this year on intellectual property protection and market access symbolize the degree to which China is now committed to the world economic system.

That the economic clock was not turned back after June 1989 is a decisive indicator of the practical impossibility of a retreat to isolation now that so much of China's economic well-being is bound up in contact with the outside world, and now that China's urban citizenry is exposed through modern communications to life outside.

Economic decisionmaking power will continue to devolve from the central government to local governments. Regional identity has deep roots in Chinese history, and the regions have differing economic strengths and interests. With the move away from rigid socialism as an ideology, and with a new generation of leadership in Beijing, regionalism is likely to intensify. The coastal areas, and particularly the southern provinces of Fujian and Guangdong, will continue to grow rapidly, due to their proximity to the outside and, in particular, to Hong Kong and Taiwan, which provide so much of their capital and managerial expertise. As a practical matter, companies entering the China market will find that their business counterparts at the local level are more and more able to act decisively without central bureaucratic interference.

This trend in no way implies, however, that the central government will collapse in the manner of the Soviet Union. Despite regional differences, all Chinese share a strong sense of national identity. Even as its authority declines, the central government should retain ultimate control of the money supply, and its approval will remain critical for major investment projects.

Government Involvement

China will continue to make significant moves in the direction of a market economy, but a strong measure of government involvement in the economy will remain a fact of life. Market forces and market prices are already the determining factors in a majority of economic transactions. In 1992-1993, the government is, for the first time, moving toward meaningful price reform for previously sacrosanct commodities, such as coal.

But the social consequences of mass unemployment will likely make it politically impossible for the government to allow major state enterprises to fail. This will limit the degree to which the management of these enterprises can be responsive to pure market forces.

It must be recognized in doing business with China that specific investment priorities have been established and these influence the responsiveness of government agencies to business proposals. Emphasis is directed particularly toward improvement and expansion of the basic infrastructure such as roads, railroads, telecommunications, and energy, as well as the range of other basic natural resources essential to domestic development and as exports.

The economy will continue to grow in patterns of boom and retrenchment cycles. When economic booms appear to be excessive and inflation threatens to become severe, the central authorities have demonstrated an ability to take corrective measures. These measures are similar in many ways to anti-inflation actions of Western central banks, including particularly restraints on monetary expansion. Of fundamental importance, as these cyclical fluctuations occur they have proven to be just that - temporary in nature - and business expansion has not broken its rapid strides.

Outlook for the Near Term

Last year, despite wide and deep recessionary forces across the Western world, the Chinese economy actually accelerated. GNP growth for the first nine months of 1992 reached an annual rate of 10.6%. While inflation rose to an officially reported level of 8% for urban retail prices and 10% for capital goods, it is not affecting standards of living, which continue to rise in the cities. It is my impression, based on conversations with a variety of officials and ordinary people in China, that the population is now more accustomed to living with moderate inflation. Therefore, I would expect the economy to continue to grow rapidly for at least another year or two, and it shows no sign of reducing consumer confidence and spending.

In boom periods, spending on imports increases across the board, especially when foreign exchange reserves reach the level ($40 billion) achieved by the end of 1991. There are encouraging signs, moreover, of loosening in China's import control regime. These range from the country's commitment, in the October 1992 market access agreement with the United States, to reduce tariffs and eliminate import licensing over the next three years, to the large number of new trading companies and industrial enterprises that are permitted to engage in foreign trade.

The net result is that the environment for capital investment, as well as consumer spending, will continue to be attractive, overriding such fluctuations as changes in the overall growth rate and inflation.

With regard to specific action, establishing a significant market position in China will require an operating presence there, given the size and complexity of the market, the cost of serving the market from a distance, and China's determination to develop its own industry and services. While operating a joint venture or a subsidiary in China remains a difficult challenge, the investment environment continues to improve, as reflected in the following trends:

* The joint-venture and wholly owned subsidiary companies constitute by far the most dynamic segment of the economy. China is now absorbing foreign investment at the rate of $6 billion per year.

* Joint-venture companies are enjoying greater access to the Chinese domestic market. In the face of growing consumer demands and capital requirements for improved infrastructure, marketing monopolies are being toppled and new channels of distribution are being opened.

* Governmental authorities are far more willing than previously to approve the establishment of wholly owned operating subsidiaries, or joint ventures in which the foreign partner owns a large majority. And the central government is giving local governments, that are enthusiastic advocates of foreign investment, increasingly greater authority to approve joint ventures on their own.

* Access to foreign exchange with which to purchase imported materials and repatriate profits is gradually improving. The growing diffusion of foreign exchange among domestic enterprises under export revenue retention schemes, and the increasing liquidity of the so-called "swap centers" at which domestic currency can be exchanged for foreign currency at gray-market rates, has increased foreign exchange availability for joint ventures. The total turnover of these centers has risen at about 50% annually in the last couple of years to about $20 billion in the latest 12 months.

The Strongest Opportunities

In this changing environment, I see the strongest trade and investment opportunities for foreign companies in several sectors.

Consumer Goods. The spectacular success of the pioneering joint ventures involving name-brand consumer goods companies, such as Procter & Gamble, Coca Cola, and SmithKline Beecham (manufacturer of Contac, a.k.a. "Kangtaike"), demonstrates the degree of the appeal of these goods to Chinese urban consumers who, despite their low wages, have enormous aggregate savings and thirst for new products and a more comfortable life. It has always struck me how responsive Chinese viewers are to television advertisements that their more cynical American counterparts would quickly tune out. Consumer goods manufacturers have the unique opportunity to cement their identity with the world's largest population.

The opportunities for manufacturers extend to companies in the retail business as well. China has officially sanctioned investment by foreign retail companies, and many cities are now offering land to the retailers.

Nondurable consumer goods, it should be noted, are not subject to the vagaries of the Chinese boom-retrench business cycle in the way capital goods are. While the business of most foreign companies in China fell off dramatically in 1989-1990, consumable goods continued, for the most part, to show steady growth.

The market for durable consumer goods, particularly electronic ones, is more mature in the big cities. But more sophisticated goods, such as air conditioners and, to some extent, automobiles, are probably just at the beginning of a major growth cycle.

Basic Energy and Infrastructure. Since the whole economy depends on these sectors, which have been chronic bottlenecks, substantial sums will continue to be invested in power plants, oil and gas fields, coal mines, highways, the automotive industry, railroads, aviation facilities and equipment, and advanced telecommunications (including home phone service in the big cities). Foreign equipment suppliers and investors in these industries have great potential in coming years.

There remain restrictions against foreign operating participation in certain of these industries, such as telecommunications services. But the taboos against foreign participation in transportation enterprises, onshore oil and gas operations, and power plants are gradually weakening.

Goods for Export to Developed Countries. Since 1984-1985, production or assembly of toys, shoes, handbags, low-end consumer electronics, etc. destined for the U.S. and other developed country markets has gradually been transferred from Hong Kong, South Korea, and Taiwan to the southern Chinese coastal provinces, as labor rates (estimated to be 20 times cheaper on the mainland compared to Taiwan) and currency values have risen in the former and the investment environment has improved in the latter. Unless there is a deterioration in China's relations with the West, production of more sophisticated products, such as bicycles, tennis rackets, and higher-end consumer electronics, should start moving toward China as well.

The economic detente between Taiwan and China has given a tremendous impetus to this business. In the last three years, an estimated $3 billion (U.S.) in investment has flowed from Taiwan to the mainland, as entire factories move to Fujian and Guangdong Provinces. Taiwan partners with money and an understanding of the Chinese operating environment could be valuable allies for Western companies trying to penetrate China's domestic market, as well as for companies using China as an export base.

Real Estate and Services. Although the concept of commercial and residential real estate has only begun to take hold in China during the last few years, the buying and selling of property rights is already taking place at a frenetic pace in the southern coastal provinces and major cities, as Hong Kong and Taiwan investors make purchases. More and more areas in major cities are being offered to foreign companies for development over periods as long as 50 years. The infancy of the real estate industry certainly offers opportunities for Chinese and foreign players alike.

The pace of relaxation of barriers for foreign company entry into the financial services business is accelerating as well. There are now 47 branches of foreign banks established in Shanghai and five smaller southern coastal cities, and more cities, such as Tianjin, are slated to establish branches. The range of services such operations are allowed to offer will probably expand to hitherto off-limits activities, such as accepting local currency (renminbi) deposits.

The American International Group (AIG), actually founded in Shanghai in the early 1900s, has become the first foreign company to re-establish an insurance operation in China (life and property insurance in Shanghai), and more are likely to follow. The burgeoning issuance of "B-share" stocks available to foreigners for hard currencies, as well as a growing pace of activity by Chinese-owned companies abroad - including the first listing of a Chinese domestic manufacturing operation, the "Gold Cup" automotive group from Shenyang, on the New York Stock Exchange - provide foreign investment banks and securities firms with opportunities to begin China programs and grow with the trend.

Growing Eminence of Shanghai

The southern coast of China centering particularly around Guangzhou (old Canton), close to Hong Kong and readily accessible from Taiwan, has been the major beneficiary of the initial thrusts of capital and foreign trade. More recently, however, action has been underway to re-establish and enhance the position that Shanghai once occupied as a major world commercial and financial capitol.

Inducements in the form of establishing an industrial zone with incentives have allowed great strides in the development of the Shanghai area. The prospect is that Shanghai will attain a position in world commercial and financial markets that surpasses anything in the past. In fact, Shanghai is likely to rival New York, London, and Tokyo for world leadership as the country continues its rapid development.

In approaching the China market, the economic fundamentals make it unmistakably clear that this is a country, in itself and in its area of the world, that is in the front rank for investment interests. With about 1.2 billion people, China accounts for one-quarter of the total world's population. It occupies an area larger than the U.S. or Western Europe as a whole.

As noted above, it has been and continues to grow at a rate unmatched by any other area. Additionally, the Chinese economy is taking off from a comparatively low base of per-capita income, and its population is striving to overcome its consumer deficiencies. All of this is being given practical expression in material development by a population that is continually ranked, intellectually and culturally, at the top rungs of world communities.

Virginia Kamsky is the founder and Chief Executive Officer of Kamsky Associates Inc., a firm engaged over the past 14 years in investment development in a wide range of industries and finance in the Pacific Rim and, in particular, in China. Fluent in Chinese and Japanese, she has offices in New York, Hong Kong, Singapore, and Beijing.
COPYRIGHT 1993 Directors and Boards
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Copyright 1993 Gale, Cengage Learning. All rights reserved.

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Title Annotation:China
Author:Kamsky, Virginia
Publication:Directors & Boards
Date:Jan 1, 1993
Previous Article:The pendulum of history swings again.
Next Article:China's developing securities markets.

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