Chinese on march to ditch state role

Something remarkable is happening to China's financial system. Long the "soft underbelly" of China's roaring economy, recent measures suggest the Government has braced itself for some tough decisions.

That doesn't mean change will be rapid. Many observers see the reform of the sharemarket as taking up to 15 years.

Banking reform should proceed much faster, at a pace determined by the listing schedule of Bank of China (next year) and China Construction Bank (end of this year).

Both aims are far reaching.

In terms of the banks, the Government has reached the conclusion that the benefits of using them as its personal piggy bank is outweighed by the damage, waste, mismanagement and corruption which state-owned banks inflict on society.

This is pretty amazing stuff. In war, national armies need guns and bullets. In peace, unelected, authoritarian governments need control over the security apparatus and the financing to pay for it.

The banking system tends to be a pillar of such regimes.

With more than US$1 trillion ($1.47 trillion) in savings, the Chinese banks can supply a great deal of ammunition to the mainland Government.

But the Government's moves to revitalise the banking sector through overseas listings and turn the banks into market-oriented, efficient, un-ideological business instruments for retail customers and businesses are a gigantic step away from micro-managing the economy and away from using national savings at its own discretion.

Of course, the Government will continue to have a majority stake in these entities. But connected party transactions and crony deals will come under the watchful eye of international institutional investors and the free press in Hong Kong and abroad.

Many foreign investors have remained sceptical about reforming Chinese banks. In the run-up to the Hong Kong listing of China's fifth-biggest bank, Bank of Communications, big investors told the investment banks they would pay for their shares only at the lower end of the suggested price range.

That was despite HSBC owning 20 per cent of the BoComm and a general recognition that BoComm was the best of the lumbering five great state banks.

Citigroup allegedly pulled out of being a strategic investor in China Construction Bank, despite the promise of huge riches in initial public offering fees in return.

Yet in the past couple of weeks, sentiment has improved. BoComm shares were oversubscribed more than 200 times by Hong Kong retail investors and the share price jumped 13 per cent on the first day.

Bank of America has just poured US$3 billion into CCB for a 9 per cent stake and Swiss giant UBS has invested US$5 billion in Bank of China.

This is a fitting reward for the Chinese Government's risky undertaking.

The sharemarket is a separate problem and possibly even more intractable. The problem is deceptively simple.

The Government set up "sharemarkets" in the early 1990s without intending to give up any real control over the state sector.

In recent years, it's become clear that perhaps 400 of the 1400 companies are really terrible and should be delisted.

They are used as cash-harvesting machines by the Government entities which own them. Shares are issued at a steep discount, drawing in investors.

Normally, in developed markets, fear of ownership dilution would check the majority shareholder but, when you list only 10 per cent of the company, you can afford to sell a huge amount of shares before you need to worry about losing control.

Selling a tiny fraction of the company was only part of a Government's plan to retain control. The other part was to create a separate class of shares (state shares) which denoted ownership but were not meant for trading on the sharemarket. They could be sold only in specially authorised, laborious transactions off the exchanges.

However, the Government has announced its decision to change the state shares into normal shares and to sell them.

That means a huge supply of new shares is about to come on to the market, with disastrous consequences for existing share prices.

But the Government knows that only by getting rid of that huge overhang of Government shares will new domestic and international investors venture into the market.

It also knows that forcing Government shareholders to sell their stakes is the only way of reducing their baleful influence on the market.

What's startling about this plan is its sheer scale. Of course, we've seen privatisations of state assets before, notably in Britain under Margaret Thatcher.

But in these countries, the Governments merely owned stakes in some major utilities rather than two-thirds of all listed companies.

Again, many observers have expressed scepticism about the plan. Can the Government really prevent a collapsing sharemarket? It's trying to, by limiting the number of shares majority shareholders can sell in any given year.

But that policy will probably not attract buyers into the market, since the threat of increased supply remains latent. Why buy something today if it will be cheaper tomorrow?

Yet while everyone agonises over the supply problem and the (admittedly tricky) implementation, few have acknowledged the extraordinary fact that the Government has broadly acquiesced in the privatisation of the totality of the listed Chinese industrial sector.

There will be cost to that, but if the Government succeeds, the long-term rebound in the markets will put that cost in the shade.

* The writer remains anonymous to protect his position in China.