Chinese outward investment: More opportunity than danger

The huge stash of reserves ties directly to two core issues in China’s outward investment that are themselves closely related: the motivation for (most) outward investment and the role of state-owned enterprises (SOEs).

Official reserves grew by $453 billion in 2009, $448 billion in 2010, and $197 billion in the first quarter of 2011 alone—the PRC’s huge contribution to global imbalances. The money must be put somewhere. Under Beijing’s own, staunchly defended balance of payments system, foreign money cannot be invested in domestic projects. This is not a matter for debate; foreign money physically cannot be spent at home.

The main objective of the State Administration of Foreign Exchange, hence, is nothing more than to store a great deal of money in a comparatively safe place overseas. At $3 trillion, this is not easy. Most foreign markets cannot absorb even an appreciable fraction of this total. Large losses of the funds, the “blood, sweat, and tears” of the Chinese people, risk a popular outcry. So money is stored chiefly in U.S. government bonds.

Since the beginning of 2005, the PRC has also invested over $250 billion outside of bonds. The large majority of this much smaller figure was used to acquire stakes in what Beijing designates as valuable strategic assets: natural resources and, to the extent possible, technology. Other goals include enhancing political influence. The Chinese state has little interest in strong returns on its foreign exchange, since this merely adds to money that cannot be used at home and subjects China to criticism for creating global imbalances.

Chinese firms can have interests different from those of the state itself, but with regard to outward investment, the interests largely coincide. That is because state entities, especially very large and centrally controlled state entities, dominate outward investment by volume.

Heritage data are biased toward state entities because they have an inordinate share of the capacity and backing to make the large deals. Still, the results are overwhelming.

It is a good sign that the state share appeared to drop noticeably in the first half of 2011. There are also indications of recent diversification within the state, with more locally owned state firms participating in large-scale outward investment. Nonetheless, just four entities - oil giants China National Petroleum Corporation and Sinopec, sovereign fund China Investment Corporation (CIC), and metals conglomerate Chinalco (in descending order of investment volume) - account for about half of Chinese spending since 2005.

This should not be a surprise. A global presence is a key attribute of the national champions the PRC is working to create. The government’s “Go Out” program was aimed first at large state firms. Further, it focuses on sectors in which state firms are required by law to be dominant, such as energy and construction. 

Gigantic subsidies, such as multibillion-dollar loans on highly concessionary terms from state-owned China Development Bank, are provided to state firms making desired investments. Those moving beyond core interests see investments rejected by regulators.

China Invests: Where and What

Chinese outward investment has a short history, but the timeline also points to the major role the Chinese state has played. Until late 2004, outward investment was confined to a few friendly countries, such as Sudan and Pakistan. Then Lenovo’s purchase of IBM’s personal computer unit seemed to indicate it was possible to purchase American non-bond assets on a large scale. The rejection of a bid for UNOCAL by China National Offshore Oil Corporation (CNOOC) in mid-2005 almost immediately closed that door.

As an investment target for the PRC, Australia is quite similar to America, and after a major Chinese state firm had been blocked by the U.S. government, others shifted their attention to Australia. Less than two years later, attention shifted to sub-Saharan Africa. By 2009, the primary focus was South America, with the most intense investment to date in 2010. South America alone has now drawn over $60 billion in Chinese non-bond investment. It is entirely possible that North America will be next: There is a herd mentality among large state investors.