Backgrounder: Investing in China

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China's economy, the second biggest in the world, is expanding at a dramatic pace, while many other large economies are struggling. While this may present an opportunity for investors, it is important to be mindful of the potential risks involved. Here are some key facts to consider before investing your money in the Chinese market.

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Economic Expansion
China's GDP has risen extraordinarily since 1978, and the National Bureau of Statistics of China estimated the country's gross domestic product (GDP) in the first quarter of 2012 to be nearly 10.8 billion yuan. The bureau reported that this growth rate constitutes an 8.1 percent increase over the same period last year.

The official 2012 forecast for GDP growth is 7.5 percent. Although lower than previous years, this is still high compared with Western countries. Keith Fitz-Gerald, global investing expert and chairman of the Fitz-Gerald group, suspects it might actually end up between 8 to 9.5 percent.

U.S. Investment
Victor Manuel Rocha, senior adviser for Foley & Lardner and former U.S. ambassador to Bolivia, said that since 1978, China has embarked on a "historic and unprecedented rate of growth no other country has ever experienced in modern history." In fewer than three decades, China raised a record number of people from a subsistence level to middle class, consumer levels.

Rocha explained that in the past two decades, China has attracted record U.S. foreign investment, ranging from Microsoft to McDonald's. General Motors, for instance, sells more in the Chinese automotive market than in the American market, so GM and its shareholders benefit from significant investment in China.

Difficulties
Investing in foreign markets is not without its difficulties. Robert Lawrence Kuhn, an international investment banker with expertise in China, listed five major problems for American investors:

  • high valuations/excessive P/E ratios
  • accuracy and consistency of financial information
  • volatility of markets
  • looser insider trading practices (and lack of compliance)
  • corporate agendas other than increasing shareholder value.

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However, Kuhn noted that China's leaders are committed to solving these problems so the country can emerge as a major player in the global financial market. Doing so will require adherence to international standards.

Transition from export to consumption-based economic model
Some experts believe that after 30 years of rapid growth, China must make some changes. Weyman Gong, chief investment strategist at Signature Financial Management, explained that after the financial crisis of 2008, China's leaders realized that a predominantly export-driven model would no longer be sustainable. The 12th official Five Year Plan (2011-2015) outlined a transition toward consumption-led growth away from the country's over-reliance on exports. Gong said the transition to a consumption-driven economy will not be easy, but if the transition is successful, China will continue to grow at a high pace throughout this decade.

Urbanization
The government's 12th Five Year Plan outlined another reason China will likely sustain high growth rates: the urbanization of China's millions of rural residents. Since urban residents often have higher incomes and contribute more to GDP, Kuhn sees great growth potential in this ongoing movement. This transition is already underway. The Chinese government reported that about 480 million people lived in Chinese cities by 2001. Now, over half the population, approximately 690 million live in cities. China's 2012 economic and social development plan stated that the country will increase the number of urban jobs by more than 9 million.

Political Risk
The extent of the Chinese government's business involvement often adds many levels of bureaucracy, according to Jeffrey Karp and Truman Bidwell, partners at Sullivan & Worcester, who have experience dealing with China. Bidwell said, "One must be aware that rules can change unexpectedly based on the decisions of the central government."

The presence of China's government will not disappear from the economic sphere anytime soon, resulting in a land of nuances--great opportunity but significant political involvement. Bidwell pointed out that the Chinese government recently passed a law "requiring all Chinese lawyers to swear allegiance to the Communist Party and its officers." The ramifications of this action for client confidentiality, among other things, are unclear, he said.

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