Asia monitor

Discussions about private equity in China almost invariably focus on the growth of its domestic buyout and venture capital markets. Using this as one's barometer, it's easy to conclude that progress so far has been less than spectacular. The buyout market is undoubtedly growing, but lags behind regional neighbours such as Japan and Australia. The venture market is also gathering momentum, though the twin complexities of culture and regulation still act as a barrier to foreign participation.

But taking only the domestic arena into account implies the kind of insularity that China is doing its best to shake off. The country is in fact doing its level best to reach beyond its borders.

Take CITIC Group, for example. Founded in 1979, CITIC is China's largest government investment company. Typical of today's more outward-looking China, it recently launched the ¥20 billion (€149 million; $184 million) CITIC Japan Partners LP fund alongside three Japanese partners: Marubeni Corporation, Shinsei Bank and Sumitomo Trust & Banking.

The fund has been set up to assist Japanese corporations in accelerating their expansion into China. It will provide capital to companies that have strong growth potential in China, particularly in the auto, electronics, industrial machinery, chemicals and pharmaceutical sectors.

The fund's formation coincides with the release of a seminal statistic by Japan's Ministry of Economy, Trade and Industry (METI): in 2003, China accounted for almost 25 percent of Japan's exports, thus becoming its largest export market for the first time ever.

The statistic is a surprising one, particularly given that relations between Beijing and Tokyo remain somewhat sullied by the memory of Japan's imperialist past – a memory that still has the power to impinge on the present in unexpected ways.

A few years ago, sales of Toshiba laptops in China plummeted when it emerged that the Japanese electronics giant had paid compensation for an alleged product defect to US customers but not those in China – prompting some hostile war-related rhetoric in the Chinese media. Neither should it be assumed that trading conditions between the two countries have been particularly benign: in a recent report, METI complained about an “extremely large” number of Japanese companies operating in China that have found it difficult to obtain details of local regulations from officials, never mind comply with them in the required timeframe.

But China is still perceived as today's land of opportunity, and one is tempted to question whether the efforts of organisations like CITIC to attract foreign business are in fact necessary. After all, there is no lack of overseas investors eyeing up China without any public sector encouragement.

A good example again comes from Japan. When local private equity firm Phoenix Capital recently announced the purchase of a 33 percent stake in Mitsubishi Motors Corporation (MMC) for ¥74 billion ($677 million, €560 million), observers seeking a rationale could have been forgiven for scratching their heads. This was a struggling business beset by a cover-up of design flaws and subsequent vehicle recalls, which saw sales in June (shortly before the Phoenix deal was completed) drop 64 percent in Japan and 46 percent in the US.

But a source close to the transaction told PEI that the rationale was to free MMC of the global aspirations of controlling share holder DaimlerChrysler and to focus it on the Chinese market instead. Under the terms of the deal, DaimlerChrysler's 37.7 percent controlling stake has been diluted to just under 25 percent, a level at which it no longer has operational control. The source confides that Phoenix will almost certainly at some point seek to grow the business into the burgeoning Chinese market, where vehicle sales grew 75 percent last year and whose car market is forecast to be the second-largest in the world behind the US in 2007.

Neither the CITIC fund nor the Phoenix deal may assist the growth of China's domestic private equity industry. But they are nevertheless examples of the ways in which private equity can be used to feed the country's exploding consumer market and, as a result, provide further economic stimulus.

And it is not just Japan that is providing the fuel: just think of what combining Chinese low-cost manufacturing with Indian software expertise stands to achieve. In this development too, private equity will undoubtedly play its part.