Investment bankers on starvation rations as the M&A slump bites should get busy learning Mandarin, because there are growing indications that China is about to make its presence felt in global capital markets. Chinese policymakers have been debating with increasing urgency how to gradually divest themselves of the $1.7 trn of dollar paper assets they have accumulated, without precipitating a dollar crisis in the process.While recent bilateral trade deals with commodity exporters like Brazil help to stem the flow of fresh dollars, even China's much reduced trade surplus with the US means its dollar pile keeps growing. Buying $50bn in IMF SDRs offers only a marginal diversification against $800bn of Treasury holdings alone (although it does help to internationalize the yuan). The $300bn CIC, which is effectively China's sovereign wealth fund, is now exporting dollars at a furious pace, largely to invest in private equity but also recently buying 17% of Canadian miner Teck Corporation.
In recent months, the approval process for overseas investment by private Chinese companies has been greatly simplified, as has access to foreign currency credit lines. Although we continue to see large energy focused deals, such as the $1.7bn PetroChina investment in Canadian oil sands, strategic acquisition targets span a range of second-tier companies operating in resource markets from uranium to rare earth metals. The debacle surrounding the attempted Rio and Unocal investments has convinced Beijing to set its sights lower in terms of corporate targets.Technology also remains a key focus, particularly battery and alternative energy know-how that can help domestic manufacturers achieve critical mass. As well as accelerating M&A, China is also likely within months to allow local retail investors access to foreign markets for the first time, via global ETFs and managed funds, again releasing domestic capital into international markets. How significant could these moves be for international markets?
After being pegged to the dollar for many years, the Yuan gradually appreciated by over 20% against the dollar after Chinese policy changed in response to US pressure after 2005 (not out of line with other major currencies such as the Euro) but as the credit crisis hit since July 2008, the Yuan has been officially manipulated again to help exports. The forward price reflects expectations that China’s re-peg will persist. But a fundamental change of policy is now being discussed in Beijing; as Chinese imports have soared from the rest of Asia this year, reflecting the impact of consumer oriented stimulus spending, and exports to the US and Europe may now be facing structural decline, a stronger rather than weaker currency is increasingly attractive.
The effort over the last decade to 'sterilize' dollar earnings by failing to repatriate them( which would force a Yuan revaluation) but instead parking them offshore in US assets has turned into an economic trap. As with Japan in the late 1970s and 1980s, China is now seeking to accumulate foreign economic assets to help offset the costs of a Western style demographic structure in coming decades, a legacy of the one child policy. While full convertibility is still many years away given the structural problems of the Chinese economy (notably a relatively backward financial system), the road-map to its achievement is becoming clearer, and in the near term it implies a partial opening of the Chinese capital account. That will be marked by an accelerating outflow of Chinese capital into international assets over the next few years, and anticipating where that flow will be channelled will offer attractive investment opportunities.
