China insider exposé is explosive and predictable

October 26, 2012

By John Foley

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

Fix one problem, and along comes another. On the day China expelled disgraced politician Bo Xilai from its parliament, a New York Times investigation alleged that Premier Wen Jiabao’s family controls financial assets worth $2.7 billion. The suggestion is explosive, particularly of a leader who has spoken out about inequality. But it is also mundane, and won’t much change the calculus for investors in the People’s Republic.

With only around three weeks until Wen makes way for a new premier, the risk that this becomes a social hot potato is slight. China’s censorship machine works as efficiently as ever: visits to the New York Times website were swiftly blocked. Blog users discussed the story, but only in euphemism, referring to Wen by names like “Wo Jia Baobao” – “My baby”. Though the details are juicy, the idea that China’s elite are very rich is hardly surprising.

For investors, it might even be reassuring. Many have staked large sums of money on backing entrepreneurs with connections. Private equity firms, and Western investment banks, have made billions of dollars from pre-IPO investments struck by knowing the right people.

There is thus no contradiction in the fact that China is the world’s top destination for foreign direct investment, with $59 billion in the first half of 2012, according to United Nations data. Investors worry less about unorthodox systems and insiders than they do about unpredictability. India, by contrast, struggles to attract investment because its unpredictable and pervasive corruption is far less conducive to healthy returns.

True, the long-term effect on the economy is corrosive. China lost $3.8 trillion in the past decade through capital flight, suggests a report from Global Financial Integrity – far more than it attracted in foreign investment. And outsiders – including investors in the public markets – are short-changed. That might explain why stocks in Shanghai and Shenzhen look cheap on most measures.

For now though, China’s system is one that many large investors feel they can work with. Even regular folk have developed coping strategies. Consider this year’s civil service examinations, which are on course to attract a record number of applicants – in some cases with 9000 applications for a single post. That power breeds money is China’s worst kept secret.

 

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