Chinese Direct and Financial Outbound Investment
China is an emerging investor in business abroad via overseas direct investment, and is also exploring options to invest in international financial markets. China became the third largest outbound direct investor in 2012 and, in conjunction with plans to reform its financial sector, is examining ways to potentially increase financial flows abroad as well.
While the ongoing economic slowdown has dampened China’s overseas direct investment (ODI) in 2014, the long-term trend points to an increase in ODI. Outbound direct investment is dominated by state-owned and state-controlled enterprises, and much of the ODI is carried out through mergers and acquisitions. Outbound direct investment from China is catching up to inbound direct investment from other nations into China, weighing in at $90.2 billion in 2013.
China’s outbound FDI regime began with the Going Out policy developed from 1999 to 2001. The Going Out policy encouraged overseas investment, contracting, and resource procurement. The cumbersome approval process for outbound investment projects was streamlined after the success of reforms piloted in Shanghai, Jiangsu, Zhejiang, Shandong, and Guangdong. The application and authorization procedures were further simplified in 2005 and 2009. State-owned enterprises can now apply to MOFCOM for authorization of projects between $10 million and $100 million, while projects under $10 million can proceed without approval.
The Twelfth Five Year Plan on Inward and Outward FDI stated that the government will support the participation of firms in natural resource projects and industrial upgrading, and encourage private enterprises to use outward FDI. China has invested in developing nations in Africa, often for natural resources, as well as in developed nations in Europe and elsewhere, to obtain the advantage of technology transfer. Indeed, China’s ODI across the African continent in mining, manufacturing, and infrastructure highlights strong endeavors by Chinese enterprises to expand abroad.
Outbound financial investment, while minimal today, is also on the table. The Asia Financial Risk Think Tank based in Hong Kong SAR, for example, is in the process of documenting ways in which China may consider outbound foreign financial investment. Strict capital controls continue to block outbound foreign financial investment, but the potential for the development of foreign financial investment is vast, and China’s institutional and retail investors alike can benefit from diversifying assets abroad. Allowing capital outflows for the purpose of financial investment is currently under discussion.
Precedents for outbound financial investment from China are few, but include China’s sovereign wealth funds. The China Investment Corporation (CIC) has been most visible in this area, investing in a number of foreign assets. Controlled by the Ministry of Finance, CIC is registered as an independent non-bank state-owned enterprise, unlike other sovereign wealth funds. Although a recent audit revealed losses due to investment in firms such as Blackstone and Morgan Stanley, CIC has learned from its experience and continues to obtain returns abroad. An aggressive strategy implemented in the early years of its operation has been modified to a more moderate strategy based on investment in equities and other assets rather than high-yield assets purchased via absolute return vehicles such as hedge funds.
The CIC case may increase the incentive to first open overseas financial investment to state-owned banks rather than non-bank state-owned enterprises, as state-owned banks may undergo emergency liquidity injections where necessary. State-owned banks are under the purview of the People’s Bank of China. In addition, the CIC case illustrates the danger in taking an aggressive financial position, particularly given low levels of experience in investing abroad. It also shines a light on the need to ensure adequate management and accounting procedures.
Consideration of outbound financial investment comes at a time when China’s leadership is attempting to further marketize its financial sector, enhancing returns and other market signals. Overseas financial investment is a wide open field that has the potential to provide risk diversification and returns to institutional and retail investors, if managed properly. Like overseas direct investment, overseas financial investment may play an important role in providing China with much-needed resources (in the latter case, financial) to expand economic growth.