Tuesday, June 24, 2008
Here’s an interesting story about the foreign investment approval process in China, and in particular about how the RMB valuation problem is infecting policy in strange ways all across the board.
A lawyer for a foreign law firm in China told me about his experience negotiating with the foreign investment approval authorities in a certain large, commercially sophisticated city. His client was acquiring a privately owned Chinese firm in that city. In accordance with relevant regulations, a valuation report had been prepared by an independent appraiser. The price negotiated by the parties (unrelated parties negotiating at arm’s length), however, was 50% than the appraised valuation.
A market price higher than an appraised value is not surprising or indicative of anything wrong; Chinese appraisers often rely on book values that take no account of certain intangibles and future earning power. In the past, foreign acquirers have run into difficulties with approval authorities when the negotiated price was lower than the appraised price; the authorities, who have more faith in the solidity and apparent objectivity of book numbers than in evanescent and subjective market valuations, would suspect that assets were being sold off cheaply to crafty foreigners, or that kickbacks or other underhanded dealings were involved.
In this case, however, the authorities objected that the negotiated price was too high. The foreign buyers should pay less money. When asked what an acceptable margin on either side of appraised value might be, they responded, “10 percent.”
What’s going on here? The problem is that apparently approval authorities are now more worried about hot money inflows than they are about Chinese sellers getting taken to the cleaners by crafty foreigners. They just don’t want all this money coming into the country. Surely there is something wrong with an exchange rate policy that leads to this kind of result. Michael Pettis over at the China Financial Markets blog has written frequently about the dog-wagging effect on monetary policy of the tail of exchange rate policy; here’s another dog being wagged.
By the way, the resolution of the lawyer’s problem is as interesting as its original cause. The lawyer insisted that the negotiated price couldn’t be changed; it was the product of four months of hard bargaining between the parties. (Who could have imagined that a lawyer would be put in the position of saying, "My client insists on paying more than you want it to pay!") Eventually the approval authorities were convinced that the price was reasonable. The agreed solution? Amend the appraisal report!