The current financial crisis further highlights the role of
Chinese bond investment in the U.S. economy and prompts questions
about whether Chinese investment in equities or other assets would
be helpfulin addition. Some in Congress are concerned that China
will stop buying American bonds. At the same time, there is alarm
over the extension of Chinese investment beyond bonds in the U.S.
and around the globe.
For these and many other reasons, China's outward investment
raises serious questions for American policymakers and the public.
Chief among them is intent. The Chinese economy is still controlled
by the state and, thus, so is its outward investment.The
objectives and performance of the key actors involved are largely
opaque. In the absence of transparency, many analysts believe that
Chinese investments are driven by political, not commercial, goals.
This possibility is especially troubling in light of the massive
financial resources at China's disposal.
The stakes are too high to make assumptions. This paper is a
step toward providing open-source information that can help
evaluate the Chinese intentions based on the facts, reassuring or
disturbing, about their investment decisions. It starts to answer
the questions of why, who, where, and how much the People's
Republic of China (PRC) invests overseas, as well as why there has
not been even more investment, given China's potential.
These facts lead to one immediate conclusion: The main problem
with foreign investment by the PRC is a serious lack of
transparency. China has embraced the Generally Accepted Principles
and Practices for Sovereign Wealth Funds (GAPP) guided by the
International Monetary Fund (IMF), but has a great deal of work to
do to make its foreign investment practices transparent.
Less pressing, but still helpful, would be additional
transparency on the American side, both for the purposes of
welcoming legitimate Chinese investment and negotiating with the
PRC on greater market access. New regulations guiding the Committee
on Foreign Investment in the United States (CFIUS) are a step in
the right direction. In the international sphere, the U.S. should
first compile information on Chinese spending in various regions,
then review possible policy responses.
Why China Invests
Lack of transparency has generated suspicion of Chinese motives.
Until recently, Beijing proceeded like any cautious investor,
placing the vast majority of its funds in the safe haven of
American government bonds. The last four years have seen a
much-discussed drive to acquire foreign mineral assets but, much
more significant in quantitative terms, have also seen Chinese
state-owned enterprises drowning in cash and searching for an
investment outlet--any investment outlet.
The financial crisis shows painfully how too much liquidity
breeds overextension. The PRC is spending, and unintentionally
wasting, a great deal of money in part simply because it has
accumulated so much money through trade surpluses and purchases of
foreign currency to defend the yuan. There is no conceivable
balance of payments for the massive foreign exchange pile; it is
almost twice as large as annual imports and debt accumulation
combined. Hypothetical large-scale government purchases of imports
to benefit Chinese consumers clash with the core objective of
developing local industry. Moreover, the non-convertibility of the
yuan, to which Beijing is just as staunchly committed as to
developing local industry, means that reserves cannot be spent on
domestic needs, a terrible waste.
This odd set of conditions makes for a very odd implication:
Public talk aside, there is little practical value in gaining
higher returns from investing reserves. Achieving higher yields would
merely earn more foreign currency, which the Chinese government
cannot use within the system it has created.
Hence, other motives for outward investment are at least as
important. These are largely political. One aspect is domestic:
U.S. treasuries appeal to Beijing because they cannot suffer
visible and gigantic losses or outright defaults the way other
bonds and stocks can--losses that infuriate the "Chinese street"
far more than abstract complaints about merely 2 percent
Outward investment can also bring foreign good will by providing
the liquidity sought by policymakers worldwide in response to the
financial crisis and from job creation. As Japan did in the 1980s,
China can investoverseas in part as a political strategy to protect
lucrative trade links. Purchases of American bonds certainly fit in
this category. The PRC can also secure outright political gains in
small countries. In January 2008, China's State Administration of
Foreign Exchange (SAFE) bought $150 million in U.S. dollar bonds
from the Costa Rican government as part of a 2007 agreement under
which Costa Rica cut ties with Taiwan.
On the commercial side, investment activity begets better
investment activity as experience is gained. Acquisition of equity
stakes and joint ventures bring managerial learning and exposure to
better corporate practice. Majority stakes, of course, bring
control of either physical resources or of unique corporate
This relates to the main objection to Chinese spending: In the
U.S., it is a means to acquire technology; elsewhere, it is a
resource grab of physical assets such as oil fields. There
is a non-commercial component to the behavior of state enterprises:
Following national priorities in securing mineral supplies can
trump market valuation. Non-commercial investment bids up
commodities prices beyond the additional demand naturally
introduced by China's growth. In addition, SAFE takes small
stakes in strategic sectors like energy to serve national interests
without inciting a protectionist reaction.
It is documented in later sections that the amount devoted to
physical assets is far less than the amount stored in safe
securities such as U.S. T-bonds. That merely augments the
conclusion that strategic considerations are more important than
commercial in most outward investment decisions.
Why China Invests
1) To store balance of payments surpluses
2) To acquire valuable assets
3) To defend foreign trade links
4) To assuage domestic agitation
5) Other foreign political goals
6) To maximize returns and increase the pile
Who Are the Players?
One common error is to view Chinese foreign investment through
the prism of the China Investment Corporation (CIC), the explicit
sovereign wealth fund. In fact, CIC is a minor player, at least by
Chinese standards. The headliner in this drama should be SAFE and
its $1.9 trillion in reserves at the end of September 2008. The
second act is a group of state financials, which have acted as a
distributive channel for the overflow of foreign money pouring into
SAFE. State-owned non-financial enterprises have also invested
heavily overseas in recent years, often funded by government lender
China Development Bank.
It is no contest. SAFE will shortly hold 10 times the assets of
CIC, is presently adding the equivalent of at least two CICs
annually, and is the largest securities investor in the world. It
is an arm of the central government and should function as the
definition of a sovereign wealth fund. SAFE's holdings of American
bonds were approximately $1 trillion by the end of June 2008.
These holdings flow naturally from the fact that China runs a trade
surplus with the U.S. China must do something with those
In an obvious bit of bureaucratic competition, SAFE began to
move beyond bonds in 2007 coincident with the creation of the
CIC.SAFE is permitted to invest 5 percent into
assets other than bonds, a number that passed $90 billion by the
end of September 2008 and grows higher each month.Other than
American bonds, SAFE's major outlays appear to be in Britain,
where, in barely over a year, it invested more than $16 billion in
firms from banking to utilities. All stakes are less than 3 percent
and need not be disclosed under British law. This connects to
a critical issue: SAFE is secretive, its activities uncovered only
by outside investigators after the fact, and usually even then
denied by SAFE.
The activities of China's state financial institutions have also
been poorly documented. They received massive sums of foreign
exchange as a means of capitalization. In the last two years,
they have been ordered by the People's Bank to hold larger amounts
of foreign currency as part of required reserves. In both cases,
the money was transferred from SAFE, otherwise official reserves
would be even larger. Brad Setser at the Council on Foreign
Relations calculates the amount of foreign money at Chinese state
banks at no less than $430 billion at the end of June 2008, on
extremely rapid growth over the preceding 18 months.
Well down the ladder, then, is CIC. Its high-profile launch and
well-trained executive team made it the face of China's foreign
investment. CIC's promises to abide by market norms, including
those pertaining to transparency, were intended to offer
reassurance about its investment. But CIC has been nearly
irrelevant from the outset. Two-thirds of its $200 billion
endowment is allocated to domestic banks as capital.
That leaves less than $70 billion for "overseas" spending, but even
that includes initial public offers by mainland companies in Hong
The last set of players is state firms, with a helping hand from
two of the state's national-level policy lenders, Export-Import
Bank of China and, especially, China Development Bank.
These have invested a comparable amount to CIC--though over a
longer period--in Africa, the Middle East, and elsewhere searching
for energy and metal ores. Their acquisitions are transparent, or at
least visible, but sometimes made on a non-commercial basis because
the firms are instruments of national strategy.
CIC is widely designated as a sovereign fund. SAFE is
increasingly, and properly, recognized as a sovereign fund.
State-owned banks are tightly connected to CIC in administrative
structure and have behaved similarly to SAFE. The major investors
among state-owned firms, such as China's oil giants, are tightly
held. It is a diverse set of names making China's purchases
overseas, but they are all very closely related. As such, Chinese
foreign investment is best understood as almost entirely
What China Invests In
It is also an error to view China's foreign investment through
the lens of a few controversial events, such as China National
Offshore Oil Corporation's (CNOOC) failed attempt to buy Union Oil
Company of California (UNOCAL). In particular, while
equities and direct investment receive most of the attention, the
core of China's foreign investment consists of American government
Over half of SAFE's holdings appear to be official American
debt, both treasuries and agency debt, such as bonds issued by
Freddie Mac. As of September 2008, China was the largest holder of
U.S. treasuries at approximately 6 percent of the total. SAFE began
moving into U.S. agency debt in 2003 when China's foreign reserves
began to mushroom.For currency balancing, it holds official
European and Japanese debt as well. There is corporate debt of many
The composition of state banks' holdings has been obscured by
SAFE's larger investments.Some banks have disclosed small positions
in troubled institutions and companies, such as Fannie Mae or
Lehman Brothers, but there is no external public auditing of their
true exposure.In the aftermath of the financial crisis, at least,
the political relationship between state sector and central
government makes it likely that in 2009 the state will purchase
U.S. treasuries almost exclusively.As for CIC,the financial crisis
did reveal a multi-billion dollar placement with an American money
market fund that likely reflects much more money placed by all
Beyond bonds, SAFE now also capitalizes foreign investment funds
and buys equity stakes in individual foreign entities, such as
British Petroleum. CIC does, too, though so far not very adeptly.
Acquisitions of both equity stakes and physical assets by
state-owned enterprises range widely and geographically and in
terms of sectors.
State banks have made a few discrete equities investments and
also operate through a government-controlled program for foreign
equities investment by commercial entities. Approved Chinese
institutions apply to act as mutual funds in the U.S., as well as
in Britain, Hong Kong, Japan, Korea, and Singapore. Less than
one-third of the $42 billion authorized under this program has been
invested. But regulators have worked to jump start
the program and, when global stocks recover from the current
crunch, Chinese institutional investors could quickly become major
The principal concern with respect to the large investment in
bonds is that it may stop or even unwind. The concern over the much
smaller investment in equities and physical assets is that it will
continue and intensify. This is partly because such investment has
been concentrated in the sensitive areas of energy, finance, and
Metals, not energy, have been the leading target for Chinese
investment, with nearly $43 billion committed in less than five
years. China's all-time biggest foreign non-bond
investment was made by Aluminum Corporation of China, spending
$12.8 billion--with partner Alcoa spending $1.2 billion--for 12
percent of multinational mining company Rio Tinto. While aluminum is
important, iron and steel are the main focus, as with Minmetals and
Xinxing Iron's planned venture with India's Kelachandra and
Manasara to produce 6 million tons of iron pellets annually and
build a 2.5 million ton steel mill in Karnataka, India, for $2.2
The PRC has committed approximately $40 billion to purchase
energy assets of various types. It may be surprising that
energy is not the principal target, but the number of energy
acquisitions peaked in 2006, and then tapered off somewhat as the
cost of assets mounted. If pre-2005 transactions were included,
energy would be the largest sector for China's foreign investment.
And more energy investment emerged in the third quarter of 2008
when crude prices dropped from their peak.
Government arms and state firms have spent the money all over
the globe. In May 2006, China Petroleum and Chemical Corporation
(Sinopec) paid nearly $700 million for control of three Angolan oil
blocks. In April 2008, SAFE paid $2.8 billion for 1.6 percent of
the French oil and gas company Total. The sum goes higher if
agreements to construct power plants and aid for power distribution
are included. There has been more than $8 billion in awards of
these kinds as well as outright power investment in the past four
years, highlighted by State Grid Corporation of China's
participation in a consortium that won a 25-year, $4 billion award
to operate the Filipino power grid.
The leading sector in drawing contracts, however, is transport
and logistics, featuring port management and highway construction.
Investment in the sector stands at only $1.5 billion, but more than
$16 billion in large engineering and construction contracts was
inked from January 2005 to September 2008.
Most relevant to the global financial crisis, more than $25
billion was committed in finance, all from May 2007 through the
third quarter of 2008. In addition to the stakes taken in Morgan
Stanley and Blackstone by CIC, SAFE contributed $2.5 billion to a
fund created by Texas Pacific. The largest single transaction was
outside the U.S.: Industrial and Commercial Bank's $5.5 billion
purchase of 20 percent of Standard Bank of South Africa, with an
eye on financing China's activities on the continent.
How Much Is China Investing?
Addressing what China is acquiring naturally extends to how much
it is spending. Available data provide only a partial answer. We
know that China's acquisition of overseas assets using accumulated
foreign currency, though extremely large, is far from the largest
in the world.
U.S. portfolio holdings overseas stood at $7.2 trillion at the
end of 2007, having expanded by $1.2 trillion in 2007 alone. In
comparison, China's official reserves stood at $1.53 trillion in
2007, or less than one-fourth of the U.S. total. Official reserves
increased by $460 billion in 2007. In addition, foreign currency
holdings in the hands of CIC and state banks rose by as much as
$160 billion. Combined with official reserves, that is
still only about half of American investment for 2007.
A relatively small proportion of foreign currency is held for
any length of time as actual cash. Much, perhaps even most, of
China's reserves are held in U.S. bonds. With so much money on the
move, China's bond positions are fluid.
Chinese U.S. Treasury bond holdings were $585 billion at the end
of September 2008, and holdings of U.S. agency debt were
approximately $447 billion at the end of June. Treasuries are
more closely watched but, as foreign money has poured into China
from trade and investment, return purchases of U.S. agency debt
soared. Investment categories also include corporate bonds and
positions in the money market. Chinese holdings of these types in
the U.S. were probably less than $100 billion combined at the end
China is officially the largest foreign bond investor in the
U.S., passing Japan. Total Chinese holdings of bonds and similar
securities are over $1.1 trillion. In the current environment, this
is less than two years' worth of U.S. government bond issues. It
does understate the true amount, since some investment attributed
to offshore sources, such as the Caymans, is Chinese in origin. In
the third quarter of 2008, agency debt, corporate debt, and money
market positions all likely fell in value as a result of the
financial crisis, and growth in the value of China's reserves
slowed, but Chinese purchases of U.S. treasuries increased. The
Chinese bond market is extremely immature, and American bond
holdings in the PRC are scarcely one-tenth of 1 percent the size of
total Chinese holdings in the U.S.
Non-bond Investment. The value of Chinese investment in
U.S. equities in mid-2007 was $29 billion and may not have
increased from that point, despite fresh investment, given the
magnitude of stock losses. This is a negligible amount of the U.S.
equities market. It is also minor in comparison to the U.S. equity
position in China. U.S. holdings of Chinese stocks were estimated
at $96 billion, 2 percent of market capitalization, at the end of
2007. It is worth noting, however, that China
could become the dominant foreign player in U.S. stocks by shifting
a portion of its bond investment.
What China calls outward investment is the focus of a great deal
of foreign attention. Official data are not particularly reliable,
especially when first issued.They are categorized into
non-financial investment and financial investment, where the former
is subject to major revisions and the latter is irregularly
reported and invariably seems far too small.
China's outward non-bond investment almost doubled in 2004,
officially, but there is scant public information to verify that
claim, much less earlier figures. Chinese foreign investment as a
global phenomenon, not only aimed at a very small group of
countries, was first recognizedin 2005. It soared further in 2006,
and then flattened out somewhat in 2007 at a level roughly 5
percent of the size of outward bond investment. By the end of 2007,
excluding bonds, China had invested as much as $117 billion
overseas, whereby 7,000 domestic entitiesestablished 12,000
subsidiaries in 172 countries or customs zones. In the first
three quarters of 2008, official Chinese investment easily
surpassed the 2007 total.
Despite the leap in 2008, official figures do not appear to have
kept up with the pace of activity of the past two years and may
again be revised far upward. For 2005 to 2007, the
Heritage dataset is expected to generate smaller totals than
Chinesedata. And total investmentis smaller in 2005. By 2007,
however, the Heritage figure shoots past the official number. The
gap then widens considerably in the first three quarters of 2008.
From 2005 through the third quarter of 2008, Chinese data show
$93 billion in outward investment. The Heritage total is $120
billion. If our data are more accurate--they could be more accurate
while still not being particularly precise--the stock of all
Chinese outward investment at the end of September 2008 may have
approached $160 billion. In the third quarter, the bulk of the
investment was in oil, signaling a return to that market in light
of better valuations. The financial crisis deterred activity in the
fourth quarter and may do so as well into 2009. In comparison,
American direct investment overseas was many times higher at $314
billion in 2007, with accumulated stock at $2.8 trillion.
Finally, U.S. direct investment in China itself was $6 billion
in 2007, with accumulated stock of $28.3 billion. There is no
official Chinese figure for direct investment in the U.S., and
American figures, using a different definition, show it as
negligible.Following Chinese practice in surveying
foreign investment, 2007 was the most active year yet for Chinese
spending in the U.S. At the end of 2007, the stock of Chinese
non-bond investment in the United States was almost certainly much
smaller than U.S. non-bond investment in the PRC, but it is now
conceivable this can change.
Where Is China Investing?
Of particular interest in international affairs is where China
is spending. SAFE's lack of transparency in particular and the
growing role of offshore financial centers undermine the value of
Chinesefigures. It is clear that the PRC'sbond investment is
heavily focused on the U.S., but less clear how much has been
invested, on a final basis, in other markets. Reported Chinese
investment in Japan is much, much smaller than in the U.S., at
$65.6 billion at the end of June 2008. The same applies to other
major investment targets, such as Germany, where reported Chinese
investment is much smaller than in the U.S., even granted that it
is understated in light of routing through offshore centers.
While bond investment is clouded, the Heritage dataset provides
additional information on China's global investment in equities,
direct investment in physical assets, and large-scale engineering
and construction work. Equity stakes are naturally concentrated in
more developed economies where attractive companies are based.
Direct acquisition of physical assets and major contracts are
widely distributed. The expansion of Chinese business into Africa
and the Middle East has received attention, but Australia is the
single largest investment target.
Chinese non-bond investment in the U.S. through the third
quarter of 2008 features 11 large transactions involving more than
$15 billion, chiefly overpayment for financial partnerships such as
SAFE providing $2.5 billion in capitalization to a fund created by
TPG (the former Texas-Pacific Group). While this is trivial
compared to the size of the American financial sector, the first
large investment did not occur until May 2007. There have also been
smaller technology investments, such as Wuxi PharmaTech buying
AppTec Lab Services for $150 million. The rest of the Western
Hemisphere drew only $7 billion, chiefly to buy Canadian-owned
assets in Latin America.
The United States is not the largest target of Chinese non-bond
investment. That honor goes to Australia. The Heritage dataset
contains transactions worth over $20 billion, spearheaded by the
$12.8 billion from Chalco. There were also several billion dollars
in large transactions from 2003 to 2004. The trend is steeply
upward. The value of Chinese applications to the Australian Foreign
Investment Review Board between November 2007 and June 2008
exceeded $28 billion, compared to a total of $8.5 billion in fiscal
years 2006 and 2007 combined.
East Asia saw transactions valued at $13 billion, including more
than $6 billion in engineering contracts, led by Singapore, which
is also a leading site for small-scale Chinese equities purchases.
West Asia, including Iran, the Russian Federation, and the Indian
subcontinent attracted over $22 billion in investment, chiefly in
Surprisingly, the Arab world drew only $7 billion in investment
but, tellingly, twice that in large engineering and construction
contracts. Even the latter did not emphasize energy, but transport.
Some of the clamor over China's acquisition of energy assets is
On the other hand, sub-Saharan Africa has received considerable
attention as an outlet for Chinese investment and it drew $25
billion, led by the Democratic Republic of Congo and Nigeria. This
number may be something of an understatement, since the 2005 start
for the dataset neglects considerable Chinese investment in Sudan.
Details on the investments are especially difficult to obtain and
recent dollar figures may be inflated for political reasons as the
amounts simply cannot be spent at present. In addition, a larger
portion of outlaysthan elsewhere is attributable to concessionary
Europe received $15 billion in Chinese investment as well as a
very large port development contract in Greece. In addition, hidden
investments in Britain have recently been uncovered. The Heritage
dataset identifies only five large transactions valued at $6
billion in the United Kingdom, led by policy lender China
Development Bank. However, local media in September discovered
small stakes accumulated by SAFE in more than 50 British companies.
The total value of SAFE's stakes was calculated at more than $16
Why Not More?
The trend clearly points to additional large sums of Chinese
foreign bond investment and more explosive growth in Chinese
foreign non-bond investment. The trend may very well continue, but
there are powerful forces gathering in opposition, especially to
the non-bond investment.
Auxiliary to the Heritage dataset of large non-bond transactions
from 2005 is a series of troubled or failed transactions initially
agreed to by the principals. These began to emerge in higher
quantities, at least publicly, in July 2006 and have steadily
increased since. This is partly a function of more attempts
naturally breeding more failures and partly a function of greater
attention paid to Chinese investment. Related to that, however, is
increasing opposition outside and inside the PRC to China's "going
Twenty-eight such troubled or failed transactions are identified
since the start of 2005 involving more than $100 billion. Certain
deals appear on both lists of completed and troubled transactions,
but the value of whole and partial transactions lost make it clear
that China's outward tilt could have been significantly greater. By
country, Australia demonstrates its acceptance of Chinese business
by appearing far down this list despite being the single largest
recipient of foreign Chinese non-bond investment. The American
political roadblock to theCNOOC-Unocal deal in 2005 assures the
U.S. the position of the most reluctantinvestment
By sector, two investments made by CNOOC totaling $34 billion,
the second in Iran, have been effectively blocked by the U.S.,
skewing some of the numbers. Blocked energy investments total $38.3
billion, all of them from July 2005 to June 2007. In contrast,
nearly all of the $30 billion in troubled financial investment
occurred in 2008. The results help explain the general perception
that it is energy and finance where China is most rapidly acquiring
Foreign Barriers. One of the most obvious factors in the
international resistance to China's foreign investment is the
absence of reciprocity. Beijing has labeled the bulk of its economy
as essentially off-limits. One of the principal benefits of Chinese
investment overseas is the incentive it can provide to the PRC to
integrate further into the world economy, including more foreign
access to its own markets. There are already examples of effective
swaps in market access. SmallAmerican specialty bank UCBH won
access to the Chinese market in part by selling a stake to
Mingsheng Bank. China Construction Bank's purchase of
Bank of America's Hong Kong unit occurred after the two established
a relationship through Bank of America's purchase of Construction
The principal reason why China's outward steps are blocked is
foreign suspicion; the principal reason for that suspicion is the
PRC's lack of transparency. The biggest culprit is SAFE. It holds
far more foreign exchange than all other Chinese players combined,
yet has fought the commitment to disclosure which at least has been
offered by CIC. For their part, state banks and state firms have
disclosure requirements connected to being public entities. In the
case of entities listed only in Shanghai, these requirements are
not ideal. However, they are still infinitely better than SAFE's
disclosure requirement, which is presently non-existent.
When SAFE restricted its activities to the U.S. treasury market,
its reticence was less important than its wallet. Now that it is
buying a growing number of equity stakes, that may no longer be
true. This goes well beyond the United States. SAFE declined to
even acknowledge the arm used to take the dozens of positions in
London stocks and insisted Costa Rica hide the large bond purchase
it made in that country. To be fair, there are transparency
failures in recipient countries, as well. In the U.S., what is said
to be off-limits to China is subject to political pressure and thus
changes with circumstance, rendering unpleasant the operating
environment even for desired Chinese investors.
The U.S. has raised other objections, of course. Private equity
investors BainCapitalbrought in Chinese telecom company Huawei to
participate in its acquisition of 3Com because Huawei had a
non-compete clause with 3Com. The U.S. Congress objected, the deal
collapsed, and 3Com simply moved its headquarters from the U.S. to
China.Since then, the CFIUS mandate has been
altered, featuring new federal government departments, an expanded
scope of inquiry, definition of key terms, and more communication
with Congress. For most transactions, these alterations should make
for a more transparent and possibly less politicized review
In comparison, the top recipient, Australia, has
tolerated politically and processed bureaucratically a flood of
Chinese investment. Canberra has extended the examination process
for new investment applications and acknowledged closer scrutiny of
investment by state entities and market share in commodities
supply, but that is all.
A caveat: The financial crisis is having a possibly undesired
impact. Shougang Steel's stake in Australian iron miner Mount
Gibson Iron was originally limited by Australian regulations. As
their demand for steel crumbled, key Chinese customers for Mount
Gibson's iron defaulted. This left Mount Gibson hurrying back to
Shougang to sell the larger stake that was originally denied. It
may be that financial need among Australian firms will cause the
Australian government to interfere more often on grounds of
Chinese Barriers. Even if the world were to ignore issues
of reciprocity, transparency, and other matters and welcome Chinese
investment with wider arms, the Chinese floodgates may still not
open. There are also qualms in Chinese corporate headquarters and,
especially, in Beijing about outward investment.
There are high-profile failures, featuring the losses suffered
by CIC in Blackstone and Morgan Stanley, but led perhaps by life
insurer Ping An's futile partnership with the EU's Fortis.
Objections are beyond the financial industry. Chinese electronics
giant TCL has had to ward off delisting after overreaching in 2004
in the acquisition of French counterpart Thomson's TV unit.Domestic steel-makers were agitated for
months by the multinational BHP Billiton's offer to buy Rio Tinto,
but admitted an inability to plan and implement a takeover of that
There would have been more failures if not for vetoes from
Beijing.Ping An's plan to buy half of Fortis' asset management arm,
for EUR2.15 billion, was blocked. Chinese regulators properly
stalled China's CITIC Securities' $1 billion share swap with
now-defunct Bear Stearns. A massive deal was scuttled when even
policy lender China Development Bank was thwarted in its desire to
offer $13.5 billion for Germany's Dresdner Bank. Indeed, Beijing
rejected all large foreign investments in financial institutions
for more than six months, well before the current crisis erupted in
One solution is to build partnerships between Chinese giants and
multinational companies. The fretting over the loss of an
independent supplier in Rio Tinto was resolved in part by China
Aluminum working with Alcoa to acquire a stake in Rio Tinto.The
Chinese may see the alliance as a template for tapping foreign
commercial experience, but also for overcoming foreign political
Perhaps more intractable and dangerousfor China is the threat to
its outward bond investment. It is well known that
inflation-adjusted investments in U.S. government bonds over the
period of renminbi appreciation, from July 2005 to July 2008, have
lost considerable value. More salient is that the system that
generates the foreign exchange being invested in U.S. bonds
requires the People's Bank to sell large amounts of short-term
bills. To keep its own costs down, the People's Bank requires state
commercial banks to buy these bills at very low yields; it then
compensates the banks by keeping (controlled) deposit rates very
low. The Chinese government has been losing money at the one end on
low U.S. bond yields and Chinese savers are still losing money at
the other end on low deposit yields.
Of course there are compelling reasons to maintain outward bond
investment. Most important, the outlays result from a system that
has kept China's exports price competitive, creating millions of
jobs. Also, were the PRC to try to sell its U.S. dollar assets, the
dollar would fall, reducing the value of China's foreign
Nonetheless, the financial crisis has turned a sticky situation
into a potentially explosive one. It has been the case that China's
own policies were costing the country money and spurring public
dissatisfaction while economic development was proceeding apace,
more than compensating for the discontent. An extended slowdown
could bring a public outcry from Chinese citizens that they are
subsidizing America, no matter the non-convertibility of the yuan.
China's Communist Party does not have to run for re-election but it
is consumed with concern over broad social unrest. As the financial
crisis might spur sometimes irrational economic nationalism in the
U.S., it might also do so in the PRC.
The expansion of Chinese foreign investment is, therefore, not
inevitable and its form can be shaped. In all cases, it is almost
sure that bond investment will be much larger than non-bond
investment. Non-bond investment may increase only slowly, but will
still sharpen competition for global assets.
Beyond that, reciprocity is crucial. Developed markets will be
walled off and competition in the developing world will be
politicized if Beijing does not permit greater foreign investment
access to Chinese assets. In the worst case, violation by a state
firm of American or international sanctions could trigger a
sustained economic conflict. In this situation, SAFE would move to
diversify away from dollars.
More likely, foreign and Chinese investment will muddle through.
The PRC will continue to restrict foreign access, but will enhance
the transparency of its outward investment. This would allow for
more Chinese acquisition of small stakes in foreign blue chips,
among other developments, with foreign control or ownership in
China still largely barred.
If transparency is supplemented by reciprocity, Chinese outward
investment could take off, especially in non-bond outlays. In the
second half of 2008, regulators in the PRC took steps to liberalize
outward investment for both enterprises and individuals.If
inward investment is also liberalized sufficiently to impress
suspicious foreign partners, Chinese foreign spending could grow to
constitute a third wave, following petrodollars in the 1970s and
Japanese spending in the 1980s.
Mineral resources will initially predominate, but emergence from
the financial crisis and accumulated experience will encourage
broader Chinese investment. In particular, if foreign stocks
recover before Chinese stocks, Chinese participation in the next
international equities rally will be considerable, including, but
perhaps not limited to, the existing scheme for Chinese
A drawback to the liberalization scenario is that competition
for financial and physical assets will increase, boosting asset
prices. American policymakers face acknowledged costs in attempting
to properly manage China's entry into the global economy on free
market principles. An attempt to foil that entry, however, would be
far more costly.
What the United States Should Do
- The Department of the Treasury and U.S. Trade Representative
(USTR) should insist during global talks that SAFE and other
Chinese government arms, not only CIC, be treated as sovereign
wealth funds subject to international voluntary best practices now
- Pending China's broad implementation of Globally Acceptable
Best Practices for Sovereign Wealth, the U.S. Congress should
ensure that CFIUS evaluates all SAFE investments on the basis of
the national security criteria that CFIUS is charged with
- CFIUS and other government review processes should be made as
transparent as possible while preserving flexibility in the review
process. The criteria by which foreign investment is judged should
be set before a submission, rather than created after the
- USTR and CFIUS should coordinate to ensure that negotiators
have information necessary to make reciprocity an explicit factor
in USTR market-access negotiations.
- The Departments of Commerce and Treasury should simplify
administrative and tax rules pertaining to partnerships between
American and Chinese firms in order that these partnerships can
more easily be used as a vehicle to expand mutual market access.
The simplifications should be part of any bilateral investment
treaty (BIT), but should not await the difficult negotiations
necessary to complete a proper BIT.
- The Department of the Treasuryshould work to ensure the success
of multilateral efforts to compile better information on the
activities of sovereign wealth funds around the globe, not only in
the more developed economies.
- U.S. policy toward Africa should include on-the-ground
monitoring of Chinese investment and promotion of awareness of the
differences between the behavior of American firms and that of the
American government compared to the Chinese practice of lending for
mineral exploitation rights.
Scissors is Research Fellow in Asia Economic Policy in
the Asian Studies Center at The Heritage Foundation.
China made headlines by becoming the largest foreign holder of U.S.
Treasury bonds at the end of September 2008. It was already the
largest foreign holder of other U.S. public debt. In just the last
few years, China has invested roughly $100 billion in Africa, the
Middle East, and elsewhere.
this paper, the standard distinction between direct and portfolio
investment is replaced by a division between bond investment in
fixed income assets and "non-bond" investment in everything else,
including equities. Chinese data do not correspond precisely to the
direct-portfolio distinction. In addition, Chinese investment is
dominated by bonds in the U.S. and non-bond spending elsewhere.
Most important, policy implications split along bonds and
everything else, not along direct versus portfolio investment.
Derek Scissors, "U.S.-China Economic Dialogue,"
Heritage Foundation Backgrounder No. 2200, October 21, 2008, at
/Research/AsiaandthePacific/bg2200.cfm; Eric C. Chang and
Sonia M. L. Wong, "Political Control and Performance in China's
Listed Firms," Journal of Comparative Economics, Vol. 32, No. 4
(December 2004), pp. 617-636; and Wu Jiao,"Party Membership Up in
Private Firms," China Daily, July 17, 2007, http://chinadaily.com
.cn/China/2007-07/17/content_5437279.htm (January 12,
"Hot and Bothered," The Economist.
"China May Cut Its Dollar Holdings--CICC,"
China Daily, September 12, 2008, at http://www.chinadaily.com.cn/China/2008-09/12/content_7020656.htm(January
12, 2009); and "Major Foreign Holders of Treasury Securities," U.S.
Department of the Treasury, December 15, 2008, at http://www.ustreas.gov/tic/mfh.txt(January 12,
Brad Setzer, "How to Handle a Couple of
Trillion," China Economic Quarterly, Q3 2008. It may be that
reserve growth at state Banks will slow considerably now that the
reserve ratio was cut to stimulate China's economy.
"China's Sovereign Wealth Fund,"
Congressional Research Service Report to Congress, January 22,
2008, at /static/reportimages/C3120D762BD11A6DE70723C8996AE8D2.pdf(January
12, 2009). As of last disclosing, CIC holds about $105 billion.
Given that domestic Banks are already swimming in foreign money, it
is possible that a transfer back to CIC could occur.
China Development Bank's major individual
outlay was $3 billion for 3.1 percent of Barclay's. It then spent
an additional $250 million to retain that stake in the midst of a
Barclay's rights offering. Oddly, China Development Bank is being
permitted to restructure as a share-holding, ostensibly commercial,
entity, while retaining its explicit policy function. See Graeme
Wearden, "China Takes £1.5bn Stake in Barclays," The
Guardian, July 23, 2007, at http://www.guardian.co.uk/b
usiness/2007/jul/23/china.internationalnews (January 12,
"CNPC Beats Out Seven Companies for Niger's
Agadem Block," IHS, June 9, 2008, at http://energy.ihs.com/News/WW-News/news-2008/cnpc-beats-ou
2009); "China Metallurgical Group Intends to Construct Integrated
Steel Plant in Philippines," China Real News, June 24, 2008, at http://chinarealnews.typepad.com/c
t-integrated-steel-plant-in-philippines.html (January 12,
2009); and "China Nonferrous to Co-Build Iran Alumina Project,"
China Mining, October 11, 2007, at http://www.chinamining
U.S. Department of the Treasury,"Report on
Foreign Portfolio Holdings of U.S. Securities, as of June 30,
2007," Board of Governors of the Federal Reserve System, Federal
Reserve Bank of New York, April 2008, at /static/reportimages/F86C0729A9F382C0B9BFB5B4EDC1C56D.pdf
(January 12, 2009); and "Major Foreign Holders of Treasury
Securities," U.S. Department of the Treasury, at http://www.ustreas.gov/tic/mfh.txt(January 12,
George Chen and Kim Yeon-hee, "South Korea
Says to Draw China Funds Under QDII," Forbes, August 25, 2008, at
wslimited/feeds/afx/2008/08/25/afx5353100.html (January 12,
2009); and "QDII Quotas Reach $42bn," China Economic Review,
November 5, 2008, at http://www.chinaeconomicreview.com/dailybriefing/2007_11_05/QDII_
Quotas_reach__42bn.html(January 12, 2009).
All sector estimates are on the low side,
because the sector magnitudes of $16 billion in SAFE investment in
British stocks cannot be fully determined and have been
Several of the energy transactions in the
Heritage dataset were provided by Wojtek Wolfe. See Wojtek M. Wolfe
and Brock F. Tessman, "The Geopolitics of China's Energy Trade: A
Method of Soft Balancing against the United States?" Meetings of
the International Studies Association, 2008.
Karen Lema, "UPDATE 4-China State Grid Group
Wins Philippine Power Auction," Reuters, December 12, 2007, at
ticle/oilRpt/idUKMAN22547220071212 (January 11, 2009).
Though not investment, large contracts of this kind, perhaps
financed by participating Chinese firms or a PRC government body,
are a major component of "going out." From the beginning of 2005 to
the middle of 2008, the PRC inked 18 large contracts with a
combined value of over $30 billion.
Numbers on non-bond investment are takenfrom
an ongoing Heritage dataset for large, non-bond investment
transactions from 2005and presently running through the third
quarter of 2008. The dataset excludes Hong Kong and other offshore
destinationsand individual outlays smaller than $100 million. It
also excludes some publicly announced investments for which
reliable information cannot be found in Iran, Sudan, the Russian
Federation, and several other countries. It includes the value of
construction and engineering contracts executed inside target
countries, but not supply contracts or any contract involving Trade
or Trade credits. Both the Heritage dataset and official Chinese
data on outward investment include loan financing, which made up
the majority of Chinese non-bond investment before 2007. "China's
Outward Investment Ranked 13th in the World in 2006," Path to
China, September 2007, at http://www.pathtochina.com/chinabiz/2007/09/chinas-o
11, 2009). Large Chinese loans were almost always made in direct
connection to access to foreign minerals and usually on such
(final) concessionary terms they are effectively grants. From 2005
through the third quarter of 2008, 80 transactions in 42 countries
are presently included in the dataset.
George Chen, "RPT-UPDATE 2-China's CIC to
Launch $4 bln Fund with JC Flowers," Reuters, April 3, 2008, at
12, 2009); "China to Invest $2.5 Billion in TPG's Latest Fund:
Report," San Francisco Business Times, June 11, 2008, at
2009); "ICBC Buys Up 20pc of Standard Bank (South Africa),"
Industrial and Commercial Bank of China, October 29, 2007, at http://www.icbc.com.cn/e_detail.jsp?
12, 2009); "Ping An Buys Stake in Fortis for $2.7 Billion,"
Reuters, November 29, 2007, at http://www.iht.com/articles/2007/11/29/business/insure.php(January
12, 2009); and Michael J. de la Merced and Keith Bradsher, "Morgan
Stanley to Sell Stake to China Amid Loss," The New York
Times, December 9, 2007, at http://www.nytimes.com/2007/12/19/business/19cnd-morgan.html?
snyt&emc=rss(January 12, 2009).
Extrapolation from "Report on Foreign
Portfolio Holdings of U.S. Securities, as of June 30, 2007," Board
of Governors of the Federal Reserve System, Federal Reserve Bank of
New York, April 2008.
"Report on U.S. Portfolio Holdings of Foreign
Securities, as of December 31, 2007," U.S. Department of the
"Major Foreign Holders of Treasury
Securities," U.S. Department of the Treasury; "Report on Foreign
Portfolio Holdings of U.S. Securities, as of June 30, 2007," Board
of Governors of the Federal Reserve System, Federal Reserve Bank of
New York; "Report on U.S. Portfolio Holdings of Foreign Securities,
as of December 31, 2007," U.S. Department of the Treasury; and U.S.
Department of the Treasury, "Historical Data," Treasury
International Capital System, at http://www.treas.gov/tic/shlhistdat.html(January
In 2007, Chinese non-financial investment was
originally estimated at $18.7 billion, then climbed to $24.8
billion. Jiang Wei, "Non-Financial Investment Rises 6%," China
Daily, April 23, 2008, at http://www.chinada
12, 2009). In comparison, non-financial investment was only $1.7
Wei, "Overseas Non-Financial Investment Rises
One reason for the disparities may be that it
is not clear SAFE's recent non-bond investments are counted in
official totals.Nor is it clear CIC's activities are counted. Inany
case,the Ministry of Commerce clearly struggles to catalog rapidly
growing investment in a timely fashion. Not only the size, but the
raw number of large transactions jumped in 2007, and then again in
A major source of discrepancy is that the
Heritage dataset uses corporate announcements to fix the time of
the investment, so some of the 2008 money Heritage includes was
certainly not yet spent. On the other hand, Heritage is unable to
fix times for and, therefore, excludesacknowledged SAFE investments
in British stocks in the several billions of dollars in 2008. And
the Ministry of Commerce is admittedly late in counting outward
investment. The smaller Heritage figure for 2005 is likely
explained by the preponderance of investmentssmaller than$100
million, which are excluded. All data are affected by an increasing
tendency by both China and its partners to exaggerate Chinese
U.S. Department of the Treasury, "Historical
Most of this is in equities and not disclosed
publicly because stakes in individual companies are small. The true
number is higher again due to the use of offshore investment sites.
"Appendix: Outward/Inward Portfolio Investment (Excl. Securities
Lending)," Bank of Japan, December 8, 2008, at http://www.boj.or.jp/en/theme/research/stat/bop/bop/dlong/fuhyo2/
(January 12, 2009)
"Ping An Buys Stake in Fortis for $2.7
Heritage location data is based on where the
asset being acquired is located, rather than where the company
owning the asset is headquartered. Note that we again exclude Hong
"Secret Investments Reveal China's Stealthy
Advance Into UK Plc," The Telegraph, September 22, 2008, at
(January 12, 2009). SAFE's acquisitions feature transactions not
counted in our dataset because comparable information for other
countries is not available. For a list of small transactions, see
"SAFE Investments in UK-Listed Companies," The Financial
Times, September 12, 2008, at http://www.ft.com/cms/s/0/8b39a890-8011-11dd-99a9-
Scissors, "U.S.-China Economic Dialogue."
"Bank of America Doubles Down on China
Construction Bank," International Herald Tribune, November
17, 2008, at http://www.iht.com/articles/2008/11/17/business/17bank.php(January
12, 2009); and Keith Bradsher, "Chinese Bank Is Buying Some Bank of
America Branches," The New York Times, August 25, 2006, at
Countries%20and%20Territories/China(January 12, 2009).
Jason Simpkins, "Beijing Flexes Financial
Might to Turn Costa Rica Against Taiwan," Money Morning,
September 12, 2008, at http://www.moneymor
ning.com/2008/09/12/costa-rica-safe (January 12, 2009);
and Ben Harrington, "China Builds Up £9bn Stake in Top
British Companies," The Telegraph, September 7, 2008, at
(January 12, 2009).
Matthew Stevens, "Iron Ore Minnow Mount
Gibson Iron is Still Swimming," The Australian, November 4,
2008, at http://www.theaustralian.news.
12, 2009). There are plenty of examples elsewhere, such as the top
company China National Petroleum Corporation (CNPC) that sought
$2bn of Rosneft's IPO, but was given only $500m; "CNPC Invests
$500M in Rosneft's IPO," Xinhua, July 19, 2007, at http://www.chinadaily.com.cn/China/2006-07/19/content_644031.htm(January
Ping An reported a 15.7 billion yuan loss on
a 5 percent stake in EU financial institution Fortis. Ping An
invested 23.9 billion yuan in Fortis, part of a drive to become a
full-service institution, but Fortis collapsed. Harroten Wolde and
Reed Stevenson, "Fortis Scraps Asset Management Deal with Ping An,"
Reuters, October 1, 2008, at http://uk.reuters.com/article/idUKLU46925520081001
(January 12, 2009).
"Chinese Steelmaker Wants Rio Tinto Takeover
Stopped," Agence France-Presse, December 5, 2007.
Keith Bradsher, "Main Bank of China Is in
Need of Capital," The New York Times, September 4, 2008, at
2009). In U.S. bonds, Beijing has invested a large chunk of savings
in assets earning 3 percent annually in dollars. Over the past two
to three years, returns have been closing on negative 10 percent
annually after factoring in inflation and yuan appreciation.