Why China Will Keep Investing Abroad

Source: New York Time ( ALAN WHEATLEY
Published: July 20, 2009 )


BEIJING — Overshadowed by a sparkling economic report card for the second quarter, the leap in China’s official currency reserves last week is yet one more reason to bank on a transformative surge in the country’s investments abroad.

But the diplomatic storm whipped up by charges leveled by Beijing against four employees of Rio Tinto shows just how bumpy the journey overseas may be if it triggers a backlash against Chinese interests.

China has long been scouring the globe for energy and commodities to feed its thrumming economy. What is new is the leadership’s determination to increase outbound foreign direct investment, or O.F.D.I., as it weans the economy off low-value, export-oriented manufacturing. The deal by Sinopec, the largest Chinese oil refiner, to buy the Swiss oil explorer Addax for $7.24 billion last month was China’s largest overseas acquisition yet.

The government is not throwing caution to the wind. Beijing blocked Bank of China’s purchase of a stake in La Compagnie Financière Edmond de Rothschild, the French merchant bank, and has responded tepidly to a bid by Sichuan Tengzhong, a little-known machinery maker, for General Motors’ Hummer unit.

But the first half of 2009 may prove to be an inflection point for Chinese outbound foreign direct investment, said Daniel Rosen, a visiting fellow at the Peterson Institute for International Economics in Washington.

“Despite short-term anxieties, Chinese O.F.D.I. is poised to grow markedly in the medium and long term, and the importance of these investments to Chinese firms is changing fundamentally as the nation confronts the need to rebalance its growth model,” Mr. Rosen wrote in a paper whose co-author was Thilo Hanemann.

With domestic economies of scale largely exhausted, companies will have a powerful incentive to move abroad to upgrade their manufacturing and compete in more profitable areas like distribution, design and branding. “Made in China” will increasingly give way to “Made by China — abroad,” Mr. Rosen and Mr. Hanemann argued.

On top of the commercial motives, greater capital outflows would make monetary policy easier to conduct by reducing China’s balance of payments surplus. Because the central bank buys most of the foreign currency entering China to cap the yuan’s exchange rate, every dollar that can be recycled as outbound investment is one dollar less that must be bought and added to reserves.

Those reserves jumped $177.9 billion in the second quarter to $2.13 trillion, helping to generate record credit and money supply growth that economists fear may be creating asset bubbles.

“We don’t know what the right amount of domestic monetary creation is, but it’s pretty safe to say it’s much, much lower than the increase in central bank reserves,” said Michael Pettis, an economics professor at Peking University.

Hence the significance of new government rules issued last week that will make it easier for companies to finance outbound foreign direct investment.

“On top of China needing to invest — they need to secure energy supplies, they need to acquire technology — there’s also the element of recycling dollar revenues,” said Qu Hongbin, chief China economist at HSBC in Hong Kong.

China’s outbound foreign direct investment has increased steadily this decade, and the outflow of $52 billion last year was a record. Still, the historical stock of the outbound direct investment of $170 billion is puny next to China’s foreign exchange reserves and its inward foreign investment stock of $876 billion.

Mr. Qu, however, said that outflows could reach $100 billion to $150 billion a year as soon as 2012. And Mr. Rosen said in an e-mail message that sum would be “entirely conceivable” if there were no political interference from Beijing.

Mr. Rosen and Mr. Hanemann identify four areas where progress, now blocked by the state’s reluctance to take its hands off the economy, is needed to promote outbound investment.