Originally Published 2005-07-07 11:37:34 Published on Jul 07, 2005
The unsolicited US$ 18.5 billion bid for acquisition of the petroleum major Unocal by China National Offshore Oil Company (Cnooc), the Honk-Kong based subsidiary of China's third largest oil company, has sent the business, and political, world into a tizzy.
Eagle in the Dragon's Shadow
The unsolicited US$ 18.5 billion bid for acquisition of the petroleum major Unocal by China National Offshore Oil Company (Cnooc), the Honk-Kong based subsidiary of China's third largest oil company, has sent the business, and political, world into a tizzy. How the US authorities handle it would be a reflection of the larger issue of how the west is able to accommodate China's inevitable rise.

For Unocal's shareholders, Cnooc's bid is one and a half billion higher than what Chevron has offered. Unocal's board had accepted Chevron's bid, obtained the regulators permission and recommended it to their shareholders when Cnooc suddenly emerged to queer Chevron's pitch. While the Chevron offer is a mix of cash (one-fourth) and stocks (three-fourth), Cnooc has offered a cash only deal that would make it more attractive to shareholders.

Cnooc's offer represents the largest ever takeover attempt by a Chinese company and has sparkled off political concerns in the US about the implications of China taking-over a US's energy company, particularly when bilateral relations are strained. Energy security has become an important political issue in the US and influential members of US Congress have expressed concern that the US should be 'losing' a piece of its energy pie to China whose unrestrained energy consumption is seen as responsible for high petroleum prices.

Not unexpectedly, the US Congress by a huge margin has prohibited the US Treasury from spending any public money in doing anything that could support Cnooc's bid. It passed another, non-binding resolution, asking President to have the bid reviewed on national security grounds. In any case, the bid would require clearance from the Committee on Foreign Investments in the United States on whether it threatened national security, and in a pre-emptive move, Cnooc has asked for such a clearance before any formal objection could be raised.

The backdrop of this Congressional pressure must be seen in the unprecedented trade surplus that China now runs against the US. The trade surplus for 2004 was US$ 175 billion, with exports at US$ 210 billion against only US$ 34 billion in imports from the US. To put it differently, imports from China represent less than 15 percent of all US imports, but accounts for 25 percent of its deficit.

The two reasons cited for China's ability to keep on increasing its exports to the US are (i) an undervalued currency and (ii) distorted playing field that allows Chinese companies to access cheap, almost free, money.

Over the past two years, the large twin deficits of the US economy, namely the current account deficit and the fiscal deficit, has ensured that the US$ has lost value against the major currencies of the world, with the Euro, UK pound, Japanese yen, Canadian $ etc all appreciating between 20 percent and 35 percent. (Over the past year, the US$ has recovered some of the ground against the Euro and the Yen because growth has spluttered in the Euro area and in Japan, but that's not very relevant to the issue under discussion.) But as the Chinese remnimbi (RMB) is effectively tied to the US$, such depreciation of the dollar has not affect the RMB adversely. In fact, it has enabled Chinese goods to improve their competitiveness against goods form from those currencies that have moved up against the US$. By way of example, the Indian rupee has gained approximately 9 percent against the dollar over the past two years.

To prevent the RMB from appreciating, the Chinese authorities keep on buying dollars. The sustained accretion to the Chinese forex reserves, US$ 206 billion in 2004 alone, has led to large reserves, over US$ 650 billion. The present value of the RMB (RMB 8.28 = US$1) was fixed in 1994. Since then the Chinese economy has more than doubled in size and its foreign trade more than quadrupled, so there are legitimate concerns that the undervalued RMB gives Chinese exporters an unfair advantage.

There are pressures on China to float its currency but this could be troublesome because of the weaknesses on the Chinese banking system whose non-performing loans around 40 percent. Capital account convertibility could lead to capital flight out of China and the RMB could conceivably weaken. That however does not seem likely, seeing the strength of the Chinese economy and its ability to attract limitless FDI.

Therefore, the pressure to revalue the currency. Estimates of undervaluation of the RMB run from 15 percent to 40 percent. In fact, there is pending bi-partisan legislation in the US Senate sponsored by Senators Schumer and Graham that would slap a tariff of 27.5 percent on all Chinese imports into the US unless China moves to revalue the RMB by significant amounts. The legislation has the support of 67 Senators, and would have been voted upon but has been kept on hold at the request of the US Administration which has sought time to persuade the Chinese to move on the issue.

A related issue has been the ability of Chinese firms, particularly those supported by the government, to access unlimited funds at low costs - some would argue at no-costs seeing the size of NPAs. In this case, Cnooc, proposes to raise US$ 13 billion from its parent company, China Offshore Oil Group (US$ 7 billion), and from the government owned Industrial and Commercial Bank of China (US$ 6 billion), with only US$ 3 billion being taken as commercial loan from international banks. In other words, Cnooc is effectively raising money cost cheaper than even the US Treasury. Chevron, on its part, has asked for this bid to be referred to the WTO, as it claims that Cnooc was attempting to acquire a critical resource with "free money".

The shrill campaign against the Chinese bid almost seems like a repeat of the anti-Japanese hysteria of the 1980s when Japan was running large surpluses against the US and Japanese companies were acquiring American assets, movie studios, Rockefeller center etc. Over the last year Chinese companies have started moving aggressively to acquire commercial assets in the west, primarily the US, e.g. Lenovo bought the personal computer division of IBM for US$ 1.7 billion, TCL has bought all but one division of the French TV major Thompson, Haier is tying up a consortium to try and acquire Maytag (US$ 1.3 billion) etc.

But each potential deal faces increased scrutiny, and national security would continue to be invoked at every step, making it harder for Chinese companies to integrate into the global economy, something that could actually serve the interests of those keen on exposing the former to real competition.

In al the frenzy about 'imminent' confrontation with China, a few facts are lost sight of. One, is that the insatiable appetite of China, and other East Asian countries, for the greenback, which are promptly used to buy US government bonds or T-bills. China alone has bought T-bills worth US$ 230 billion. Such purchases allow the US to run trade deficits, and also help keeps interest rates in the US, low. So, while it is safe for the China to become the US government's major creditor, it cannot buy a minor petroleum company that in any case, has long-term plans to supply gas to Asian countries.

The author is Visiting Senior Fellow, Observer Research Foundation.
Source: Economic Times, New Delhi, July 15, 2005.

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