Govindraj Ethiraj: For investors, China's intent is enough

DOUBLE EDGE

Last month, over the still waters of the South China Sea, on a Singapore Airlines morning service into Shanghai, a newspaper article caught my eye. It reported how China's ATM system had collapsed the day before. For seven hours. Losses apparently touched upwards of a hundred million dollars.

I got a start. I was not carrying much currency, of any denomination. Thanks to the efficiency of the Indian banking system, over the last few years, I use ATMs across the world to access my bank account in Mumbai. Or use my credit card. Instead of the old routine of buying dollars at extortionate rates and then converting locally.

On clearing immigration at Shanghai's Pudong International, I walked to an ATM machine. It worked. It struck me then, for the first time, that for all the staggering infrastructure, this was China's weak point. A Maglev train waited to blitz us at 430 kmph into the city. And yet, the country's financial system was moving at a snail's pace.

How slow? Okay, what are China's non-performing loans (NPL) like? The answer, in the usual Chinese statistical way, varies. Three weeks ago, Ernst & Young China said the country's NPLs (including the four biggest banks) stood at a mind-boggling $911 billion. The People's Bank of China, the central bank, erupted. It said the figure was "ridiculous and barely understandable" and at odds with E&Y's own figures put out earlier, which pegged NPLs for the four banks at $358 billion.

A few days later, E&Y withdrew the report, saying it was "erroneous and could not be supported". The final "settlement" figure: $133 billion, for the four banks. Incidentally, the People's Bank's estimate for China's NPLs stands at $164 bn.

E&Y may or may not have yanked the report to mollify the government, but observers were not surprised. Reports regularly surface about corruption, weak governance and the utter mess that the banking and financial system is. The highly restricted Chinese stockmarkets are considered moribund at best.

Now, you might think all this makes foreign investors a little queasy. Not quite. Two weeks later and a few days ago, the Bank of China (one of the four and the country's second-largest) offered a 10.5% stake to raise $9.7 billion in the world's biggest IPO since AT&T Wireless' $10.6 bn offering in April 2000. Initial market capitalisation, a sizeable $96 bn!

Only to be expected in booming markets, you might say. Well, as we all know, that's the week stock markets all around the world were crashing, including, most notably, our own. And yet, the Bank of China IPO was swamped with so much demand (Hong Kong retail demand helped) that a greenshoe option is most likely to be exercised. If that happens, the issue will balloon to $11.2 billion.

The Bank of China's success was not without precedent. Six months ago, the China Construction Bank raised $9.6 billion. Its stock price has risen some 50% since then. The stock price of the Bank of Communications, which listed in June last, has doubled since. The Industrial & Commercial Bank of China is next on the list, looking at a $12 bn offering in a few months.

The Bank of China must have had a good track record for such a warm reception from investors the world over. Well, that depends. If you were to ignore the $22.5 bn pre-IPO bail-out by the Government. How did it get so bad? Well, you may never really find out. Because the bank's former chairman & president, Wang Xuebing, is in prison, serving a 12-year sentence for corruption.

Maybe it's a herd of investors who got a little giddy after gazing at Shanghai's towering skyscrapers. Not likely again. The Royal Bank of Scotland Group Plc, Merrill Lynch and Temasek invested billions for pre-IPO chunks. Perhaps because they've been wooed by the Chinese government trying to meet a year-end WTO deadline of opening up its banking sector.

Possible, but why would billionaire Saudi prince and investor Prince Alwaleed bin Talal bite? He led a consortium which bid for a piece of the Bank of China as well. Not much, just $2 bn for a 2.7% stake. To top it up, his office promised there was another $4 bn to be invested in a Chinese company. The Prince's other significant other bank holding is Citibank.

You must think China has an active domestic IPO market. Actually, no. All these stocks have listed in Hong Kong. And that's not only because of the city's global financial centre status. Guess what, the mainland Chinese domestic IPO market has been shut for more than a year. The first post-freeze IPO is expected to lift shortly.

What does this boil down to? Investors across the world are buying into China's intent and promise. Whatever the size of the present mess. Investors claim satisfaction with the Chinese government's "energy" in sorting its corporate governance problem. And that the trend is in the right direction. Trust levels clearly run high.

In contrast, India has amongst the world's most sophisticated financial markets""remember the simple debit card. Top companies boast of world-class corporate governance standards. Indian banks' NPL portfolio, for instance, is unlikely to exceed $30 bn. Yet, portfolio funds, citing country overvaluation, are headed for the gate, while the Shanghai and Shenzhen stock exchanges are both rising at a time the rest of the world's markets are in retreat.

India has lagged in the FDI race with China. Portfolio money always preferred India, proportionately. China now promises it will clean up its markets. And corporate governance as well. Looking around you in China, you tend to believe intent. It's tough to do that in India, at least any more. Like repeatedly announcing a $150 bn infrastructure investment desire does not help when action is so little. Capital fleeing from Mumbai may or may not land up in Shanghai, but in the perception game, India is losing this one.