Private Equity in the Age of Globalization: China and India - Part 2 of 2

Arjun Sethi, An advisor and angel investor in early stage startups

Private equity investment in China

Today's China enjoys a major-if not dominating-role in the global private equity scheme. China's receptiveness to participation in the global trade explosion of the new millennium is surely among the biggest economic stories of the new era. Its seemingly inexorable rise in prosperity, its increasing influence in geopolitical affairs and its efforts at dominance in its economic interactions, even with fellow powers such as the United States, have multiplied the gross value of its assets, both publicly traded and exclusively held. The result has been an increasingly receptive global community, which has welcomed China's surge with a seizing of opportunity. To this end, "private equity firms are looking to become a more important part of the Chinese economy as companies there are looking for experience in become global corporate players." (AP, [2007])

Investor desiderata

Desiderata in decisions of private equity firms to participate in China's current massive growth phase include the affordability of its resources, the vast potential for growth represented in its enormous population, and an asset field that is still a frontier for many western firms. In contrast, there are a spectrum of prospective deterrents to such an investment strategy, including increased competitive saturation, social conditions conducive to future instability, and a government that is regularly accused of widespread human rights violations. An additional consideration is the potential roles beyond the reach of strict personal investment which foreign private equity firms might play in future Chinese governmental, political and social developments.

Across-the-board investor opportunities

Certainly, there is more than sufficient cause to recognize that China is rife with the opportunity for large-scale speculation, as well as with an interest in allowing foreign investors to take part in further development of its infrastructure, resource and service capabilities. Projections leading into 2006 proved correct, with Bloomberg Financial projecting that China would "attract at least $6 billion in private-equity investments . . .as buyout firms raise[d] bets on economic growth." (Cheung, [2007]) This projection would come on the heels of the previous year's eightfold expansion to $3.9 market in 2005. And these figures parallel directly what have now been two solid years of unprecedented Chinese stock market growth, where conditions have been so favorable to investors that owners of private equity funds are finding this an environment especially hospitable.

Promising stocks appearing on the Chinese market are targeted by a buying public, one that has shown itself a sophisticated interpreter of the specifics of this particularly robust economic environment. As Katherine Ng, managing director of the Hong Kong Centre for Asia Private Equity Research Ltd. indicated in a 2005 discussion, " Chinese stocks are in such a favorable position that you will find investors can dispose of their shares or holdings very quickly." (Cheung, [2007]) This is particularly encouraging to companies seeking opportunities in a country which in 2005 surpassed both France and the UK to possess the fourth largest economy in the world, suggesting that the prospects for its future growth have really only begun to be apparent or, for that matter, even definable. Investors in China seem to be aware of a continued likelihood for growth and prosperity, posting a vote of confidence in sustained growth in accordance with the current pattern. If this perception is vindicated, so too will be the various western firms that have each year in the past four added yet more funds to the economy. As a nation that is only today beginning to learn of the consumer-revenue based benefits of generating what may well prove to be the world's biggest middle-class, China is expanding so quickly and spectacularly that it has had to focus efforts on fiscal and monetary policies that facilitate, but not improperly exploit, this growth pattern.

Abandoning the self-imposed isolation of the past

Indeed, "China's reserves are growing by about $20 billion a month as surging exports bring in a flood of foreign currency, forcing the central bank to drain billions of dollars a month from the economy by selling bonds to reduce pressure for prices to rise." (AP, [2007]) Today, China represents by far the fastest growing contender to join in the global economic scheme that has to date has been largely restricted to the United States, Japan, and the European Union. Indeed, as of this spring, 2007, "China has agreed to acquire a $3 billion stake in U.S. private-equity firm Blackstone Group LPI, a deal that marks the country's long-anticipated move to expand how it invests its massive foreign exchange service." (AP, [2007]) China has shown itself to be increasingly less isolated than it had been in the years immediately following the end of the Cold War. However, it appears that today, China fully appreciates its role in the world and had facilitated its own growth within the framework of global systems initially sponsored by western powers. Its growth suggests that it has adapted to such a degree that it is now eclipsing many of its western counterparts.

China as a major player in the world currency market

The duality of China's relationship with the U.S. economy is of particular interest. Its investment in the American dollar has effectively bound much of the country's liquidity to its value. Nonetheless, the growth, which this policy has afforded the communist superpower, is now allowing it to reshape the basis of its economy. For China, investment in foreign private equity represents a mode through which it can today transfer its substantial holdings in the U.S. dollar into more robust (or at least less comatose) currencies. Referring back to its blockbuster deal with Blackstone, we can see an actualization of this strategy. The $3 billion invested in the American firm will ultimately be transferred at increased cost to the public buyer. This is a demonstration of one way in which "the Chinese government had been set to shift some of its foreign exchange reserves of more than $1 trillion into other world currencies because of the sluggishness of the dollar." (AP, [2007]) In coming years, such private equity ventures will likely prove beneficial to the Chinese government, which, in turn, will encourage a favorable monetary expansion, one that is new and separate from any dependence upon the value of a once considerably more merited U.S. dollar. This one strategic investment mode illustrates a way that the Chinese likely will redistribute private equity fund purchases to members of the Chinese public, as well as investing citizens of Asia or the European Union, through an IPO.

Special appeal to American investors

American fund investors believe even greater fluidity will eventually prevail between American and Chinese corporate and capital investment.A factor that has made China so appealing a destination for foreign direct investors is that it remains a market that has not been competitively tapped by western firms. This resulted from heretofore extensive, government-enforced restrictions on offshore investment, a policy now muted as China increasingly opens its doors to outsiders. For private equity investors in America, there is the promise that the Blackstone deal will set a precedent for reciprocity in light of this openness policy, opening wider "the door for direct stakes in Chinese companies as that nation becomes more receptive to foreign investments." (AP, [2007]) This is, of course, an extremely appealing prospect to the many companies in America, especially ones that find themselves priced into globalization strategies by the proportionally lower cost of investment. This has precipitated an impressive and growing rate of return for equity investors. In 2005, "private equity investors exited 48 China investments. . . raising $1.86 billion, compared with 46 exits valued at $1.05 billion in 2004, according to data complied by the Centre. A survey of 45 exits last year showed 44 percent of them had an internal rate of return of more than 200 percent." (Cheung, [2007]) There is almost certainly no better metric pointing to the short-term success enjoyed by organizations seizing Chinese investment opportunities in recent years.

Prospective drawbacks

Still, the outlook in China is hardly without its causes for apprehension. In fact, if there is a primary drawback, it may well be that China has been too receptive to foreign investment. Problematic from the perspective of the private equity firm is the fact that "an oversupply of capital is placing more negotiating power in the hands of the target companies, possibly limiting potential investment returns." (MQ, [2005]) This differs from the expectation and intent of private equity firms, which often operate by principle from a position of dominance. The notion of a buyout may well take the form of a hostile takeover, where the failing or immature nature of private equity holdings give them an appealing quality, while precipitating decisions of interested firms to swoop down and swallow such entities up at a low cost. While China has generally presented, and continues to present, positive opportunities for growth on an absolutely massive scale, its leaps and bounds of the last two years, capping an important decade-long expansionary period, have clearly not gone unnoticed. Indeed, coincident with the recent exponential growth of the Chinese market has been the interest of foreign firms in participating in the resolution of anticipated future national economic requirements, notably China's massive-and likely increasing-infrastructure needs.

Some economists argue that a possible outcome of this sustained growth period is a coming leveling of the market, which has until now been in an early growth stage. For aspiring investors, China may be entering a period of balance, where conditions no longer overwhelmingly favor foreign investors but instead seem ready to project an economy now entering its prime. The private equity field has become particularly dense in China, where competition for favorable entry is now genuinely fierce. Any private equity investment strategy under such conditions would be inherently counter-intuitive.

Insufficient transparency

This also raises the issue of China's questionable prospects of adherence to established principles of business ethics and practice that have shaped and fostered western capitalist structural growth. According to Richard Daniel Ewing of the China Business Review, who offered this insight in 2004, "despite the allure, a combination of developing legal systems, opaque regulations, and unpredictability makes the Chinese private equity market treacherous." (Ewing, [2004]) Indeed, the Chinese market at this juncture is still relatively green, a condition coincident with shortcomings in its regulatory capacities, but one that nonetheless threatens to undermine likely future company investments, especially among those preferring investment environments in which due diligence is the norm.

Myriad opportunities exist for outsider firms to exploit the structural inexperience of the Chinese economy, with Ewing arguing that the prior exclusivity of such markets to state-sponsorship has left its banks ill-prepared to assess and levy appropriate charges upon would-be investors. To this day, "Chinese banks loan much of their money to state-owned enterprises (SOEs) and lack the tools to analyze the credit risk of new firms with unproven technology." (Ewing, [2004]) To at least some extent, this structural inability is almost certainly related to the cultural tradition captured in the locution quanxi-the network of social relationships that often trump other considerations in business decision-making. The willingness of Americans to let an entrepreneur succeed, regardless of his or her social or political connections, has been the cornerstone of U.S. economic success, [Knowledge Wharton analyst Siegel] points out. 'People with Chinese connections can do a lot, but I'm cautious about the whole question of whether the contracts written would be upheld with the wider amount of certainty that they would in India'." (Knowledge Wharton, China or India: Which is the better long-term investment for private equity firms? [October 18, 2006]) This creates a dangerous environment for organizations that are actually prepared to make good on their committed investment promises, especially in the face of a competition driven by false claims. In short, as an investment frontier with a historically and, in many regards, continually secretive governmental/corporate culture, China's private equities market is as rife with the potential for corruption and exploitation as it is with the potential for extraordinary profitability.


On the surface, there appear to be a number of reasons to look to India as the site with a greater long term likelihood of economic growth and, therefore, a commensurately greater degree of appeal to the outside investor. There is the still extant and significant chasm separating growth rate and extension of material benefits promised to the general populace as the fruit of past investment in infrastructure development. This points to room for growth that will be interpreted as yet further exciting ground-floor projects for foreign private equity firms. One might go so far as to suggest that there is an apparent promise to the people of India for economic improvement based on the nation's attachment to democratic norms that contrasts with the restrictive social and political atmosphere of communist China.

Cronyism in China

And certainly, the research herein demonstrates a variety of reasons why we might conclude this to be the case. Significantly, today's China is a breeding ground for nepotism and corruption. The predilection of its government for crony-influenced decision-making suggests that any intent by western firms to gain influence in Chinese public policy must overcome a spectrum of institutional structural obstacles. Included among these is a government and corporate atmosphere highly susceptible to corruption.

Excessive government regulation in India

Research suggests that the Indian government is currently predisposed to business relationships that, to a significant extent, foster patronage of western corporations. India's government has already demonstrated a greater interest in constraining restrictive regulatory oversight, to the extent that corporate growth has been almost totally centered on the value of foreign investment. This differs from a China, which is largely self-sufficient and yet deeply tied to the financial affairs of western investors. As a result, a key difference for the private equity firm, is that India's greater dependence on foreign investment has encouraged adoption of a policy of stronger commitment to reliable, appealing and more likely to be honored private equity offerings, which are part and parcel of its growth strategy. The benefit here is shared by investment firms (that have found themselves welcome in India) and by the nation itself (which is generally attached of the kinds of reform fostered by capitalism, at least in its modern, western variant).

Fiscal considerations at prospective odds with western moral preferences

That notwithstanding, a more fiscally driven analysis suggests that these social and political conditions must take a back seat to the evaluation of a nation's demonstration of growth potential. In understanding some of the core differences between China and India, we may come to understand the prime conditions required for the ideal private equity investment. Specifically, Mukund Krishnaswami, managing director of Krilacon Group, an investment firm based in New York and Philadelphia makes a point that is compelling in any discussion of private equity investment. He notes that one must "look for derivative areas of economic growth and take a 12- to 25-year horizon. Those who do will be fairly compensated for the risk they're taking." (Knowledge Wharton, [2006]) He warns against using private equity as a vehicle for investing in temporary boom sectors, suggesting that such investments will ultimately prove ill-suited modes for achieving the type of profitability and success in gaining public equity buying interest, at least to the extent investors regularly anticipate. In this context, the case being made is that the relative singularity of the Indian market is problematic. While one might desire to invest in India for the inbuilt promise of its attachment to western values as well as reasonably transparent regulatory standards, it is nonetheless true, as we have established, that India is a nation which has experienced very promising, but also very specifically contained, growth.

Its economic boom can be properly characterized as occurring almost entirely within the technology and technology services sectors that, as the Knowledge Wharton article notes, are important but nonetheless limited. Though it would not be proper to describe these as isolated sectors, they are at a considerable remove from those sectors most likely to fuel any elevation of collective national living standards. This experience compares unfavorably with the cross-sector evolutions that have already swept through China. The implication here is that India's markets have not, as a whole, matured to the extent that we might necessarily enjoy a long-term confidence in the receptiveness of its consumer population to investment opportunities.

Though both nations are today in the throes of fostering the expansion of heretofore virtually nonexistent middle class populations to primacy in shaping overall socioeconomic outlooks, it is suggested that China has already shown a great deal more promise than India in the likelihood of its consumer population reaching a level of investment power commensurate with a collective rise in living standards and structural soundness.


In sum, comparative research yields a surprising conclusion: irrespective notions that political stability and social openness should together be considered more favorable to the actualization of investment and growth strategies, it appears that it would be incorrect to conclude that India as the more stable of the two nations considered. If one is to examine the various factors limning future growth patterns, there is at present far more cause to view China as moving inexorably forward and upward. Investment in its growth, from a private equity standpoint, even if committed in the midst of great competition, is at least founded on the certainty that China's growth will continue unabated well into the future. The extent to which its growth has spread across sectors and has even begun to elevate collective living standards and personal opportunities for economic mobility promises that China will ultimately boast a more able and numerous investing public than what might be anticipated in India.

Prospectively diminishing attractiveness of investment in India

In the coming decade, India will struggle to address the various issues considered here, especially with respect to its great infrastructure disinclinations and there is as yet no evidence that western firms interested in its technology sectors will necessarily extend that investment interest to further the advancement of India's building and public health sectors, as well as the overwhelming demand for infrastructure/public works projects. Absent any evidence that these must inevitably arise from today's focus on India's provision of technological services to the world consumer community, we must understand India remains a nation with vast, but as yet unproven, potential.

Given this uncertain future, it is only fair to note that the patterns of free trade thus far realized do not suggest a prospective positive outcome. Foreign investors seeking a rapid return are not so much restricted to particular economic sectors as they are attracted to relative under-development, if only because it is in the earliest stages of sector development that short term, exponential growth is actually experienced. Understood in these terms, it may well be in the individual investor's interest to abandon a maturing economy-e.g., India's-in favor of less developed ones. Of course this would have the practical effect of leaving the Indian economy in the lurch, at least insofar as prospective investment for further development was concerned. Were this to occur in India, private equity firms would likely find themselves holding a rather worthless bag, absent a populace with the capability or confidence to help them unload it.

This prospect, however, presupposes an extrapolation from near-term experience, rather than taking a long-term view that incorporates difficult to assess intangibles. Mukund Krishnaswami, managing director of Krilacon Group, an investment firm based in New York and Philadelphia, points up this differentiation. "Long term, I'm a very big bull on India. India is a country where they've done so much wrong in the last 45 years. Yet despite all that there's so much that is good going on that if they just get it right, the opportunities [will be] fabulous in 25 years," he said. "In the short-term, I'm quite a bear. I think the risk premium just isn't there in most assets to be spending a lot of money [in India] today." (Quoted in Knowledge Wharton, China or India: Which is the better long-term investment for private equity firms? [October 2006])

Long-term attractiveness of the Chinese market

As such, this research must conclude that private equity in China is the more reliable for prospective investment. The self-sufficiency of China, combined with promises of future growth on the horizon, strengthened by findings here that China itself is showing a willingness to invest beyond its own borders and even in the United States, suggest that it may be worth weathering the hazards of its problematic shortcomings in governance and social order. These, market forces seem to suggest, will ultimately ameliorate in the face of collective social advancement incident to infrastructure development. Though today both China and India both present appealing conditions for investment, as well as clear and unmistakable causes for serious caution, China is the nation whose growth is a product of genuine market conditions and not simply those precipitated by globalization. This is largely attributable to the Chinese focus on manufacturing-a function of satisfying that nation's enormous (and still growing) demand for consumer products-rather than replicating India's emphasis on the service sector. Simply stated, the Chinese market has more prospective 'staying power,' even under unfavorable conditions, that its Indian counterpart. Therefore, from the perspective of a private equity firm, market conditions are a preferred desideratum over the still questioned prospective outcomes associated with globalization.

Final evaluation

While it is the hope of globalization advocates that India's technology sector advancement will find comparable advancement in the nation's consumer economy, there is already evidence that this is occurring today in China. From that perspective, the risk to gain index is that much better in China. Given the body of evidence that China's growth is largely a function of its own domestic efforts, with resource allocation favoring multi-sector expansion, this research investigation finds that China is the better private equity investment market for the foreign investor at the present time.

Read the entire article in chapter 13.2.2.d: Private Equity in the Age of Globalization: China and India of the Encyclopedia of Private Equity.

Mr. Sethi is currently an advisor and angel investor in early stage startups. He is also a Strategic Advisor at Saset Healthcare, a start-up involved in the design and manufacture of high end ultrasound machines. Prior to Saset Mr. Sethi worked with the Carlyle Group. In 2002 Mr. Sethi co-founded Advanced Tuning Products, an ODM distributor for Garrett/Honeywell Aftermarket. He is the author of several Venture Capital and Private Equity articles, and writes regularly on his blog. Mr. Sethi holds a BA in History (Honors), from the University of Maryland College Park and BA in Liberal Studies (Honors), from Boston University.

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