China Is the Talk of Davos

Just about every conversation at the annual economic confab in Switzerland soon comes around to the Middle Kingdom

What do the world's movers and shakers talk about when they gather together to hobnob? This year, China's booming economy and what it means for businesspeople and policymakers around the world is emerging as one of the key themes at the World Economic Forum annual meeting, which is being held in Davos, Switzerland, Jan. 21-25.

Just about every big business topic seems to depend on China in some important way, from global economic growth to the weakness of the dollar against the euro, Japan's economic recovery, and the latest innovations in high tech. With 9.9% growth in the final quarter of 2003, China is Asia's locomotive economy. And if such rapid expansion continues, as seems likely, it could soon become the world's big engine.

However, the question that comes up most often is whether China, which has already attracted some $500 billion of foreign direct investment, is a gold mine or a minefield for European, American, and Japanese companies? For many, the answer is clear: "China is a remarkable story, and I am very bullish about it," says Donald Evans, U.S. Commerce Secretary. "I believe China is headed in the right direction and that it's in good hands under the new generation of political leaders that recently took power."


  China's potential is "mind-boggling," Evans contends. Its west, which is home to 800 million people, is still largely underdeveloped. So there will be huge productivity increases once capital starts being directed there. "I traveled through the west and didn't see a single tractor," says Evans. "Once they start using them, they'll make huge steps forward."

What's more, there seems to be no shortage of domestic, as well as investment, capital. China has a remarkable savings rate of about 40% of household income, one of the highest in the world. Total household savings now amount to around 100% of GDP -- three times as much as the country's total annual import bill. Foreign direct investment –- though vast –- is dwarfed by domestic investment. More than 90% of capital formation comes from within China, as Chinese companies increasingly focus on their home market.

Still, investments in China have been very profitable for some foreign companies. Evans says the companies he has spoken to say they're making, on average, pretax returns on equity of about 14%. "If you're well organized and focused and manage your operations well, it can be very profitable," says Carlos Ghosn, president of Japan's Nissan Motor (NSANY ). "It's behind the U.S. but ahead of Japan and far, far higher than Europe. That's why all carmakers are going there."


  Adds Dinesh Paliwal, the head of Automation Technologies Worldwide, a unit of Swiss-based engineering conglomerate ABB: "It's in the top tier for us. Companies that don't make money there approached the market badly in the first place or managed it wrongly once they got in there."

Victor L. L. Chu, chairman and CEO of Hong Kong-based First Eastern Investment Group, contends that 2004 "could be a particularly good year to invest in China. That's because the Chinese government is moving toward making the yuan's exchange rate against the dollar –- fixed for a decade –- more flexible, probably by pegging it to a basket of currencies that will include the euro and yen as well as the dollar.

Because that will likely raise the value of the yuan (and China-based assets) from current levels, many companies are plunking their investments down while the currency is relatively cheap. Chu says he doesn't know precisely when Beijing will make its move, but "I'm [predicting] we have a nine-month window of opportunity to get in."


  One executive who isn't waiting is Ulrich Schumacher, president and CEO of Infineon Technologies (IFX ), the German high-tech company, which is already moving some of its key technology and R&D investment to China. "We will focus more than 30% of our foreign investment over the next two years into China," he says. Infineon employs 1,200 technicians in Xian, in the west of the country, where the costs are low, skilled staff is available, and employees are far more flexible than they are in Germany.

China still has many problems. With growth accelerating, the economy is in danger of overheating, which could generate inflation. The banking system is weighed down by between 40% and 50% of nonperforming loans, financiers estimate. And most interest rates are still set by Beijing, which means banks can't price risk properly and are misallocating billions of dollars in resources. It's also heavily dependent on energy imports -- to the evident dismay of the ruling Communist Party. In fact, it has just overtaken Japan to become the second-biggest consumer of crude oil after the U.S.

Foreign investors fret that officials in Beijing are effectively protecting Chinese businesses by setting standards that favor local producers and service providers. That's especially evident on the telecom front, they say. Repatriating earnings from direct investments in manufacturing plants also can be much tougher than taking earnings from investments in stocks and bonds out of China.


  And China still lacks real protection of intellectual-property rights, some investors say. An estimated 90% of CDs and DVDs sold in China are pirated or stolen, and Ghosn says even some of Nissan's designs and logos have been copied.

Still, most delegates in Davos believe the Chinese are getting a handle on these problems. The banking system is being recapitalized. Government officials are more aware of the problems caused by intellectual-property theft. The country is moving irrevocably toward a free-market economy. And although inflation moved up to 3.2% in December, Paliwal insists it isn't causing investors great concern.

"China may be different, and it may be complicated," says Chu. "But it's improving every day -- and the opportunities are too huge to overlook."

By David Fairlamb in Davos

Edited by Thane Peterson

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