Wednesday, December 05, 2007

Something's Rotting With CIC

China Investment Corporation, the US$200 billion sovereign wealth fund set up by the Chinese government in September, was a much touted sovereign wealth fund. Initially CIC has been allocated US$200 billion, a still small portion of its US$1.4 trillion reserves.

While many thought that CIC would begin to solicit stakes in big foreign companies, including myself, their subsequent moves indicate something stinky. CIC initial US$3 billion investment into Blackstone caused me to praise their astuteness in strategy as that would allow CIC to be privy to the major deals flowing across the desk of Blackstone, and thus allowing CIC the choice to invest alongside with Blackstone. It would also limit the bad press portraying CIC as the aggressor in major M&A activities.

However, how CIC deployed the rest of the funds revealed more than they intended. A third of China Investment's portfolio is to be invested in Central Huijin Investment Company, a purchaser of bad loans from the Chinese banks, and another third will recapitalize China Agricultural Bank and China Development Bank, to shape them up for privatization.

This lends further evidence that there is still a mountain of bad debts residing in many unlisted state-controlled units. Those banks already listed, and those with major foreign banks as substantial shareholders, are those with healthier balance sheet - however, a major correction in the China stock markets and/or property side will also put a lot of stress on these so called "healthy listed banks" loans portfolio.

But thats not the major point, the main thing is that CIC would be entrusted to "recapitalise" institutions related to the hidden bad debts still residing in unlisted companies. I have mentioned before that the main reason why Beijing is slow to allow the yuan to appreciate is that its financial system is still at a nascent stage. The trade surpluses and booming stock market are only a portion of the real economy - and they need to "clean up" the underside while things are still good. Beijing is buying time - let's hope that they can do that while the stocks, property and trade surpluses are still bullish. Cause if not, the weight of bad debts will turn insurmountable almost overnight.

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