new frontiers in 'privatization'

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<http://www.washingtonpost.com/wp-dyn/content/article/2005/08/24/AR2005082402246.html>

China to Allow More Stock Sales
$270 Billion of State Assets Put in Play

By Peter S. Goodman
Washington Post Foreign Service
Thursday, August 25, 2005; D01

SHANGHAI, Aug. 24 -- China on Wednesday freed more than 1,300 largely
state-owned companies to gradually sell shares of stock now controlled
by the Communist Party government, putting nearly $270 billion worth
of state assets on the trading block. This unprecedented wave of
privatization is aimed at lifting domestic stock markets and
furthering the country's transition toward capitalism.

The plan announced by the China Securities Regulatory Commission
underscored how this land once ruled by Maoist ideology has in recent
years cast its fortunes with free markets and private capital. It also
highlighted the government's mounting concern with the sorry state of
the Shanghai and Shenzhen stock markets, which have performed worse
than any in the world over the past eight years, even as China's
economy has grown by nearly 9 percent annually.

The move is "a huge deal," said Stephen Green, senior economist at
Standard Chartered Bank in Shanghai and author of the book "Exit the
Dragon?," which examines China's privatization. "The state-owned
shares have been an albatross around the neck of the market. This is a
pretty good sign that they're serious about reform."

Ever since China established its first stock exchange in 1990,
Communist Party leaders have struggled to convince investors that they
are running a real market as opposed to a capital-raising machine in
which the government manipulates share prices to serve the interests
of favored state firms. The disconnect between China's swift growth
and its plunging stock markets has been traced to investor unease with
the structure of the companies for sale: Roughly two-thirds of the
shares of listed firms remain non-tradable, locked in the hands of
state-owned parent companies that are impervious to the interests of
minority shareholders.

The plan announced on Wednesday -- the most significant change to
China's stock exchanges since their creation -- is aimed at convincing
investors that state interference is a relic of the past, with stock
prices reflective of real values in a more transparent marketplace.

The move sets in motion a gradual sell-off of non-tradable shares
while seeking to assuage worries about a possible plunge in prices
when these shares enter the market. It also triggers negotiations
between existing shareholders and the managers of listed companies to
set some form of compensation -- either cash or additional shares --
for investors who will see their holdings diluted. The shares made
tradable would not necessarily be sold: The parent companies holding
them could opt to keep them. Those shares that are sold would be
released for purchase over time, typically over one to three years.

Analysts emphasized that the plan should not be construed as an
indication that the government has embraced wholesale privatization.
The majority of the companies that trade on the Shanghai and Shenzhen
exchanges are small arms of giant firms that remain wholly controlled
by the state, or inconsequential and poorly managed firms engaged in
such enterprises as the cement business and bicycle manufacturing. The
government's decision to put more of these shares into private hands
does not signal an intent to relinquish control over the largest and
most strategically important state-owned firms, which still dominate
key sectors of the Chinese economy such as steel, auto-making,
telecommunications and commercial aviation.

"This is basically a mechanism to get the stock market to function,
which it has not done in four years," said Arthur Kroeber, managing
editor of the China Economic Quarterly. "This is the state privatizing
junk that it's not interested in but retaining control over the core
companies."

China's bid to win investor confidence in its stock markets received
another push Wednesday with a report carried by the official New China
News Agency that the legislature plans to toughen securities laws,
giving the regulatory commission the authority to freeze corporate and
individual bank accounts in a bid to root out corrupt trading.

Analysts said the initiatives are aimed at making China's stock
markets more attractive to investors, particularly foreign banks such
as Morgan Stanley that collectively have qualified to buy up to $4
billion of stock on domestic exchanges. The control of listed firms by
the state has fostered the sense that China's markets are beset by
inside deals and shoddy corporate governance. And foreign investors
have been reluctant to plunge in until after the resolution of the
non-tradable shares conundrum -- a black cloud hovering over China's
markets, which have seen half their value wiped out since 2001.

In the past month alone, as speculation has grown that a new plan was
in the offing, the Shanghai and Shenzhen markets have each risen by
more than 12 percent. Both markets were up again Wednesday.

The Wednesday action caps a long and frustrating effort by China's
leaders to address the issue of continued state dominance of listed
companies. Four years ago, the government announced plans to sell off
state shares of listed companies to raise money for a pension system
that would compensate workers who lost their benefits under China's
pro-market reforms. But when stocks tanked in anticipation of such
sales, the government scratched the plan.

China's leaders have searched for a way to unload the shares without
decimating the markets. In May, they launched a pilot project,
allowing 46 listed companies to make all of their shares tradable.

Since then, 45 of those companies have gained the regulatory approval
needed to proceed with their plans, having won over existing
shareholders with compensation schemes, according to Green.

The negotiations have brought controversy, with some accusing the
state-owned companies of defrauding the public by giving away stock
too generously. In a commentary published this month in Caijing, a
Beijing-based financial magazine, Shan Weijian, an independent board
member of Baoshan Iron & Steel Co., the country's largest steelmaker,
criticized as unjustly generous the company's plans to hand out 2.2
new domestic shares for every 10 held. The non-tradable shares "belong
to all the people in the country," Shan wrote.

Now, the other 1,300-plus companies that trade on China's stock
markets are free to pursue such deals.

In seeking the assent of existing shareholders, the managers of listed
companies will need to win over the country's domestic mutual funds,
which have become the largest single owners of nearly every stock,
together controlling some $46 billion worth of assets at the end of
April, according to China Economic Quarterly. The total value of
China's two stock exchanges was $525 billion at the end of 2004,
according to state data.

Though these institutional investors are themselves controlled by
state-owned companies, they have generally taken an aggressive line in
negotiations for compensation, experts said. But in a clear sign that
the government is still to a degree managing the rising and falling of
China's stock markets, a senior executive at one of China's larger
mutual funds said that in recent months regulators have pressured his
firm not to sell off depressed stock holdings to help prop up the
market.

Special correspondent Eva Woo contributed to this report.