China rebalances foreign assets

Beijing turns away from bonds towards equities

How China deploys its considerable foreign assets, acquired as a result of two decades of sizeable current account surpluses, is one of the most important issues facing the world economy. Balance of payments and international asset statistics underline how China is rebalancing its foreign investments away from holdings of other countries’ debt (led by US government dollar bonds) towards greater ownership of foreign equities, with a particularly large build-up in Europe.

This redeployment is part of Beijing’s deliberate strategic efforts to gain extra leverage and value from foreign investments. It is seeking to emulate the successes of the US and other Anglo-Saxon countries in borrowing from abroad at relatively low rates of interest and investing outside the country at significantly higher rates of return.

China’s corporate spending in Europe has slowed significantly this year because of Beijing’s sharpened controls on capital outflows, introduced to damp downward pressure on the renminbi. But the underlying trend is clear and suggests China may wish to continue foreign equity purchases once balance of payments constraints ease.

Strains on the country’s international position were demonstrated by last week’s Moody’s announcement of a cut in China’s credit rating. The rating agency based its decision on expectations the country’s financial strength will ‘erode somewhat’ over coming years as debt rises – even though China’s outlook was lifted to stable from negative.

China is the world’s third largest net foreign creditor in value terms, according to data on the net international investment positions of different economies collated for OMFIF’s annual Global Public Investor 2017. The publication summarises the investment management performance of 750 public sector agencies around the world. OMFIF’s GPI 2017 report is due for release on 14 June.

The world’s largest net foreign debtor, by a wide margin, is the US. This reflects its extraordinary position as the home of the primary international reserve currency and a haven for much of the world’s savings.

The enormous debt position in the US co-exists with the country’s role as the world’s largest holder of gross assets. In the list published in GPI 2017 of the world’s 750 top public investors – central banks, sovereign funds and public pensions funds – the US accounts for around 20% of global public investable assets. China accounts for three of the world’s top public sector investors – the People’s Bank of China, China Investment Corporation and the National Social Security Fund – with assets of around 12.5% of the total.

Data on China’s holdings of reserve assets at the PBoC, which are heavily weighted to US Treasury bond holdings, compared with portfolio, direct and ‘other’ investments, which are mainly in publicly quoted and non-quoted equity, underline how China shifted its foreign investment structure during the last few years. This follows recognition by the Beijing authorities that the country was achieving suboptimal returns on its foreign investments by gearing an undue amount of its allocations towards unprofitable holdings of US fixed income securities.

China’s gross external assets at the end of last year – which may not include all the country’s overseas wealth, some of which seeped abroad via illicit channels – were roughly equally split between reserve assets and other types of investment, most of it in equities, according to publicly available data from the International Monetary Fund and other sources, compiled by OMFIF. This was a marked shift from previous analysis for 2013, when around two thirds of external assets were in reserve assets and one third in other types of investment. According to our analysis, China’s direct investments abroad roughly doubled over the last three years, reflecting the foreign corporate buying effort that has slowed considerably because of capital controls.

These data – which show a clear switch to direct investments in advanced countries and away from the developing world over the past decade – demonstrate how the PBoC’s well-publicised fall in China’s reserve assets of more than $1tn from 2014 highs has helped finance a fall in Chinese corporate foreign debt and a build-up in overseas equity holdings. Europe and North America accounted for only 3% of China’s overall foreign investment flows abroad. Their share soared to almost half of a much larger total last year as part of the foreign investment rebalancing.

David Marsh is Managing Director of OMFIF.

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