Jeremy Warner's Outlook: Relief as Sir Fred's gamble on the great Chinese takeaway is confined to modest bet

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The Independent Online

Fast back to before the European and American industrial revolutions, and China was far and away the world's largest economy, accounting for some 30 per cent of the total. Given time, there's no reason it shouldn't get back to that sort of position. Certainly that's the intention and there is little reason to think China's fiercely ambitious political leadership won't succeed. They've yet to put a foot wrong in the switch from planned to market-based economy.

No wonder chief executives are falling over each other in their desperation to get a slice of the action. Any company that intends to be around in 50 years time would be negligent if it wasn't seeking some sort of a foothold. The history of foreign involvement in China has none the less thus far been a disappointing one, and that's leaving aside the moral issue of whether it is ever right for businesses to invest in countries with such a poor human rights record.

Dictatorially run countries on the whole make very poor investment repositories, whatever their superficial attractions. The Chinese are very happy to take the West's money and expertise, but examples of decent levels of payback are few and far between. With the Chinese it has traditionally been all take and very little give.

Will Royal Bank of Scotland Group's $1.6bn investment in Bank of China, the country's second largest bank with approximately 14 per cent of deposits, be another case in point? I fear it might, notwithstanding Sir Fred Goodwin's insistence that the investment is fully protected and his decision to limit himself to just 5 per cent. Theoretically the RBS chief executive could have bought up to 20 per cent, which plainly would have been a much bigger throw of the dice.

Yet the fact of the matter is that he's quite late into the game, and as things stand there is no possibility of ever being allowed to take control Bank of China. China may have adopted many of the mores of Western capitalism, but this is still essentially a closed and politically controlled economy where inward investment is regarded as precisely that; the money and know-how comes in, but little ever comes out.

In the "strategic partnership" created by the RBS investment, the Chinese will be glad to take Sir Fred's expertise on state of the art banking, from risk control to advanced IT, yet it is not at all clear what he's going to get back in return. There is little evidence that Vodafone has ever got anything out of the similarly cemented strategic partnership it struck with China Mobile, and perhaps inevitably, the value of its stake in the company has since had to be written down.

Reasonably enough, the Chinese regard China as for the Chinese. Foreign capital and expertise is being used in an attempt to underpin what is still a deeply flawed and unstable banking system, but it is naive to believe that even in the fullness of time the Chinese will allow foreign concerns to control its major industries, companies and financial institutions. If that is what Sir Fred is betting on, then he's made a mistake.

The strategic reasons for the move are none the less obvious enough. As populations become more prosperous, there is a growing demand for financial services, which tend to grow even more strongly than everything else. As one of the pretenders to the top five slots in global banking, RBS has to secure some kind of a position in the world's key growth economy and this may be the maximum it can do for the time being.

RBS gets just 5 per cent of the equity for its $1.6bn investment, but it will speak for the investing consortium's full 10 per cent and gets a seat on the board to boot. With Merrill Lynch and Hong Kong's Li Ka-Shing as co-investors, Sir Fred could hardly have found better connected partners for his Chinese adventure.

What's more, fears that RBS would end up betting the ranch in its determination to secure a place at the table have proved ill founded. RBS and its partners are paying about 1.2 times book value, which is no more than Bank of America paid earlier this year for a stake in China Construction Bank.

For Sir Fred, the cost is neatly defrayed by selling the bank's now redundant shareholding in Banco Santander. Not a bad swap, it might be thought, but just as it was always hard to see the purpose of the similarly constructed "strategic partnership" RBS once had with Santander, this one looks equally baffling.

By confining himself to such a small stake, Sir Fred has limited his risk, but by such a degree that it's hard to see the point of it. The risk may in any case be bigger than RBS likes to admit. After years of state directed lending, the Chinese banking system is shot through with unrecognised bad debt. That such a fast-growing economy will eventually experience a severe banking crisis is a racing certainty. We can only hope that RBS is right in insisting that Bank of China is the pick of the bunch.

RBS has expanded aggressively into the US since its hugely successful acquisition of NatWest five years ago, but it has no significant presence in the Far East and its Continental assets are still quite limited. The comparatively poor rating afforded to the shares reflects continued concern that Sir Fred might allow his global ambition to blind his judgement on shareholder value. Well, to be fair yesterday's deal is hardly evidence of that.

Despite my doubts, the transaction is simply too small to make the charge stick. In that respect Sir Fred has played his cards just right. Anything bigger in the Far East right now and the markets would rightly have questioned his motives.

At the time of the last big US acquisition, Sir Fred said he'd be taking a breather from the takeover trail. Yesterday's deal demonstrates a continued appetite, but it might have been worse. One of the wilder rumours doing the rounds in the stock market yesterday was that RBS was about to bid for Germany's Commerzbank. I've heard some mad-cap theories in my time, but even if Sir Fred were the empire-building autocrat of caricature, which by the way he is not, I doubt he would ever attempt to buy Commerzbank. Even the worst that the Chinese banking sector has to offer would seem better than that.

As it is, Sir Fred has to be given the benefit of the doubt over the way he's pursuing the Chinese dream. True, he's rather gone back on his promise of a hiatus in corporate activity, but he's done it in a way which the markets will find just about tolerable. He's secured a toehold, and while the likely benefits of the strategic partnership he's won are too intangible to know if it is worth the price, the amounts involved are too small for investors to bother investors unduly.

There's still growth to be had from the British banking market, but it's slowing fast, and geographically RBS lacks to exposure to emerging market economies of HSBC or even the much smaller Standard Chartered. If the price were right, Sir Fred would buy Standard and correct the imbalance overnight. As it is is he must confine himself to a slower and less ambitious agenda.

Hedge funds and Shire's US takeover

In a comment on hedge funds yesterday, I said Shire Pharmaceuticals might withdraw its bid for Transkaryotic Therapies if hedge funds succeed in court action to force an increase in the price. In fact the bid is already unconditional, and Shire cannot now withdraw. If hedge funds succeed, Shire would have no option but to pay the extra. Apologies for any misunderstanding caused.

j.warner@independent.co.uk

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