Political flameout shows risks hidden in China

February 17, 2012

By John Foley

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Twin political flameouts in China deserve investors’ attention. The tribulations of Bo Xilai and Henry Tang teach a valuable lesson about the political risk premium.

In mainland China, there’s a political mystery. Bo, a rising star in the Communist Party, was seen as a shoo-in for the nine-member Politburo Standing Committee. But he has suffered an embarrassing setback – his right-hand man Wang Lijun apparently tried to defect. The motivations of Wang, who helped Bo rid Chongqing of several organised crime gangs, are unclear, but the affair is an embarrassment for the city’s party chief.

Meanwhile, Hong Kong’s problems are an example of political mundanity. Would-be leader Henry Tang’s campaign is crumpling because he built an illegal basement, reportedly including a Japanese-style spa, under his house. He then publicly blamed his wife. His election campaign may be done for.

Tang has made the sort of mistake that trips up politicians in democracies. Bo’s problems are harder to explain. The son of a leading revolutionary, he has rarely put a foot wrong. He introduced innovative economic incentives and reforms of subsidized housing and household registration. His fall, if that is what’s happening, follows 16 percent GDP growth in China’s most populous municipality in 2011.

But sudden political upheavals are nothing new in the People’s Republic. The purges of the Mao era saw close confidantes sent to the provinces, or worse. Some, like Deng Xiaoping, recovered and rose to greater heights. Others, like Liu Shaoqi, came to dismal ends. More lately, misdemeanours and scandals often emerge around the time of the five-year party conference, possibly as rivals throw one another under the bus.

Investors should take note of the difference between the two systems. Tang’s misstep hardly matters, because Hong Kong is transparent and the system is stable. Political risk is low. In China, by contrast, it’s incalculable. Investors are effectively buying an option without knowing either strike price or volatility. They can only assume the best or the worst. Chongqing’s mystery is a vote for the latter.

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