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Chinese outward investment: More opportunity than danger

By Derek Scissors - posted Friday, 15 July 2011


The map of China’s global footprint, including large engineering and construction contracts, shows truly global activity, with the PRC engaging every part of the planet. Where they have been unable to invest heavily, as in the Arab world, Chinese firms have built rail lines, roads, and factories. The countries attracting the most Chinese investment are Australia, the U.S., and Brazil, in descending order, with Argentina the most popular recent destination. Nigeria leads in terms of drawing large engineering and construction contracts. East Asia lags in part because some Chinese activity there pre-dates the tracker, but also because, like Europe, it has less abundant natural resources.

In terms of the sectors that draw the most interest, energy is the clear leader. The financial shock in the fourth quarter of 2008 effectively froze new outward investment for six months. It is therefore instructive to see what sector patterns have been since outward investment restarted in the late spring of 2009.

The rising price of energy has pushed up the dollar value of investments in that sector. The state energy giants continue to be willing to pay a premium, especially for South American oil assets. Though the transactions are far smaller, there is visible diversification across sectors, including the first successful spending in agriculture. Engineering and construction contracts are led by deals to build power plants. Transport sees an impressive range spanning rail lines, roads, ports, and airports.

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An important feature of Chinese outward investment is the high number of setbacks. Transactions worth approximately $165 billion have been impaired or have failed since the beginning of 2005. One reason why annual totals are growing fairly slowly, despite the huge amount of funds available, is that larger volumes of Chinese investment have been shown to be impractical over the past six years.

The volume of these troubled transactions fell sharply in 2010 but rebounded in the first half of 2011, due in part to the violence in Libya. A hopeful sign for the PRC: Companies are clearly learning to be smarter investors, as well as becoming more sophisticated. There are still deals being lost unnecessarily, but this is generally happening earlier in the process and with fewer wasted resources. The spectacular, avoidable failure is increasingly rare.

In terms of countries, it is not surprising that the top targets of Chinese firms generally see the largest amount of troubled transactions. In the U.S., if all troubled transactions since 2005 had proceeded unimpeded, Chinese investment would be almost double what it is now. There almost surely are difficulties ahead for the recent surge of Chinese spending in South America.

The singular case of America

Chinese investment in the U.S. is profoundly different from Chinese investment anywhere else. This is immediately apparent in the numbers. The Heritage figure for publicly confirmed large Chinese non-bond investments since 2005 is over $30 billion. On this tally, it is not clear that Chinese investment in the U.S. has been growing since it began in earnest in 2007, featuring a $5 billion purchase by CIC of a stake in Morgan Stanley. Moreover, the first half of 2011 was weak. Starting in 2010, though, investment diversified out of finance and out of the state of New York. It thus became healthier, less dependent on financial acquisitions by CIC.

As a proportion of America’s more than $15 trillion GDP, $30 billion is trivial. There are multiple reasons for the low share of GDP, but the simplest one is that Chinese money flows overwhelmingly to American government bonds. In other major economies, $20 billion in Chinese holdings of such bonds makes headlines. For the U.S., the total is closerto $2 trillion.

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The Department of the Treasury puts Chinese securities holdings in the U.S. at $1.61 trillion in mid-2010, led by $1.11 trillion in Treasury debt and $360 billion in agency debt from Fannie Mae and Freddie Mac. Even this figure was too low, as the Treasury treats offshore sources, such as the Cayman Islands, as independently investing more than $1 trillion rather than serving as conduits for Chinese and other national funds.

Over the four most recent years for which there are reasonable-quality data, at least 60 percent of the PRC’s foreign exchange reserves has gone into long-term American securities. The number is very likely higher that that, due to indirect Chinese investment. A sharp decline in the proportion devoted to U.S. securities in the economic expansion period of late 2006 and early 2007 was balanced by a sharp increase in late 2009 and early 2010.

Because American bonds currently offer low yields, and since there are exchange losses from a weak dollar, there is constant speculation that the PRC will abandon its position. As noted, there is no place for the money to go. The amounts involved are so large that no other economy could or would absorb them. Until Beijing changes its own rules, most of its money will remain in dollar assets, chiefly U.S. government bonds.

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About the Author

Derek Scissors, PhD, is Research Fellow in Asia Economic Policy in the Asian Studies Center at The Heritage Foundation in the United States.

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All articles by Derek Scissors

Creative Commons LicenseThis work is licensed under a Creative Commons License.

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