Updated: February 4, 2011 14:02 IST

Finance in the Forbidden City

D. Murali
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China is an economy that, from the outside, appears as a huge growth story, one extraordinary boom that has continued over the last ten years, but this is just the surface, write Carl E. Walter and Fraser J. T. Howie in ‘Red Capitalism: The fragile financial foundation of China’s extraordinary rise’ (

The authors caution that one cannot simply assume that words such as ‘stocks’ or ‘bonds’ or ‘capital’ or ‘yield curves’ or ‘markets’ have the same meaning in China’s economic and political context. “To do so reflects a lack of curiosity and seriousness that can rapidly lead to misunderstanding and wasted opportunity. It is a luxury that neither China nor its foreign partners can afford.”

While the prolonged efforts of the Communist Party and the government to mix Western capital markets with state planning have produced spectacular change in a short period, what remains obscured is the fact that all able bodies are desperately engaged in ‘the primitive accumulation of capital,’ in an unprecedented social experiment, aver Walter and Howie.

Comfort zone

For instance, the authors try to look beyond the common feeling of comfort that outside observers draw from China’s development over the past about two decades – of its ‘stock and debt-capital markets, a mutual-funds industry, pension funds, sovereign-wealth funds, currency markets, foreign participation, an internationalist central bank, home loans and credit cards, a burgeoning car industry and a handful of brilliant cities.’

As it looks like the West, international investors easily accept what they see, fret the authors. “They are excited by it because it is at once so familiar and so unexpected. There is the feeling that all can be understood, measured and valued. They would not feel this way if China explicitly relied on a Soviet-inspired financial system even though, in truth, this is largely what China remains.”

National Team

Tracing the story of corporate transformation in China, and the birth of ‘the National Team,’ the book chronicles how with strong support from Deng Xiaoping, a consensus formed around the active pursuit of equity-capital markets and SOE IPOs (state-owned enterprise initial public offerings) as channelled by Western legal, accounting, and regulatory practices; and how, within a few years, the experimentation with international listings led to the creation of perhaps the largest Chinese enterprises in history, and thus the formation of the National Team.

In the authors’ view, the National Team of huge and successful state enterprises is a game-changer in China’s political economy. They wonder, however, if these enterprises, endowed with great economic and political power, would want a domestic (or international) regulator or any other government agency to have a significant influence over their operations.

And, as for the question whether these enterprises would want China’s stock markets, including Hong Kong, to develop towards international best practice standards, the authors’ answer at this point is, sadly, in the negative.

“Its markets have all the trappings of Western finance: B-shares, H-shares, locally incorporated bank subsidiaries, local-currency derivatives, QQFII, QDII, securities, mutual fund and commodity joint ventures – all have been tried, some with great success, but they remain small extensions to the vast grounds of the Forbidden City.”

Money movements

One other aspect highlighted in the book is that it suits China’s powerful interest groups to have a complex yet primitive financial system in which money frequently changes hands. Multiple products, regulators, markets, and rules all disguise the origin and destination of China’s massive cash flows, the authors note. “In this business environment, the National Champions, their family associates and other retainers plunder the country’s large domestic markets and amass huge profits. With nationwide monopolies or, at worst, oligopolies, these business groups do not want change, nor do they believe that foreign participation is needed.”

Walter and Howie opine that the Party should never have allowed their chairmen and CEOs to remain on the nomenklatura and enjoy such great political influence. “As a result, these companies grew fat, wealthy and untouchable as they developed China’s own domestic markets and always with the unquestioning support of a complaisant financial system.”

Being so comfortable in a domestic market closed to meaningful foreign competition, the National Team faces great difficulties developing into an International Team, state the authors.

Important addition to the reading list of any China-watcher.


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