The Chinese sovereign wealth fund (which, following convention I will call the CIC) is expected to be approved later this month or early October, before the October 15 meeting of the 17th National People’s Congress.Much of its expected structure, however, is known and it has already made one very big and visible investment, the $3 billion it invested in the Blackstone Group IPO, which value began falling almost as soon as the deal was launched.As of last week the market value of the investment had declined by $600 million, causing a great deal of complaints and criticism in China, not all of it rational.
The CIC has already been approved to purchase $200 billion from China’s central bank, the People’s Bank of China (PBoC).The purchase will be funded by a RMB 1.55 trillion bond offering by the Ministry of Finance (MoF) with maturities of ten years or more.Already about one-third of the money (RMB600 billion) has been raised, with all of the rest expected to come before the end of the year.Given that China is accumulating reserves at the rate of $100-150 billion a quarter, it is probably safe to assume that if it is perceived as being successful (from the point of view of domestic political considerations, not investment performance) a lot more money will eventually be transferred into the CIC.
One bit of good news is that the PBoC plans to use these MoF bonds as part of its open market operations to control the expansion of the domestic money supply.This is good news to me because I think the use of central bank bills, which is what the PBoC mainly has used in its ineffective sterilization attempts, has been pretty much a waste of time.They are too similar to money and way too liquid to have much impact in draining China’s ocean of liquidity.The less liquid MoF bonds should do a better job.
Interestingly enough, the loss on the Blackstone IPO and the recent turmoil in the markets seems to have affected the CIC’s investment strategy, as has the international outcry against non-transparent SWF’s purchasing major strategic assets around the world.During their meeting with German Chancellor Merkel's during her visit to China at the end of August, Chinese officials promised that the CIC had no intention of buying strategic stakes in big western companies.In fact it seems that the original goal of the CIC – to maximize investment returns – has been put on hold.This is probably a good thing because, it seems to me, the most valuable use of excess reserves is as a sort of stabilization fund that minimizes the changes in creditworthiness of the sovereign borrower.Instead of maximizing returns – which is likely to be pro-cyclical and so will only increase volatility – the funds should be invested in ways that hedge Chinese risk, for example, by buying assets that perform best when conditions in China are likely to be at their worst, and vice versa.
Unfortunately that doesn’t seem to be the alternative strategy.It looks like the management of the CIC’s investments, perhaps not surprisingly given the size of the honey pot, is going to be the result of a hodgepodge of competing ministries and claims.This is what Xinxin Li has to say about it:
A seven-person executive team has been formed, representing all the interested parties. The Chairman of the Board is the vice secretary general of the State Council (China's Cabinet) Lou Jiwei, who invited the current deputy head of the National Social Security Fund (China's national pension fund) Gao Xiqing to be the CEO of the CIC. The team also includes vice finance minister Zhang Hongli, the head of Central Huijin, Xie Ping, and a representative from the NDRC. The PBoC is supposed to send a deputy governor to join the team, but the appointment is still pending. A possible candidate is the current deputy governor Su Ning…This structure reflects the inter-ministerial nature of the CIC: it is not only a SWF seeking high investment returns, but a coordinator among different government agencies on China's overseas investment.
This will be a pretty big agency.It will have 1,000 employees once it completes its expected takeover of a couple of other agencies involved in the management of domestic assets, and it will be supervised by a representatives from the State Council,, the National Social Security Fund, the MoF, Central Huijin, the NDRC and the PBoC.
Given that these different institutions have very different goals and interpret current conditions in China in very different ways, one can just as easily argue that the executive team is as likely to coordinate interests as to paralyze action. My concerns aren’t allayed by the scope of the CIC’s mission.According to Li, “Central Huijin, the former investment arm of the PBoC, will be integrated into the CIC and continue to capitalize domestic financial firms. Another existing institution, China Jianyin Investment, will mainly operate in the area of managing domestic assets and disposing of non-performing loans. In addition, the CIC will establish a new department for overseas investment.” It is also, apparently, expected to use its assets to fund the overseas expansion of domestic corporations. It is hard to imagine that domestic political clout will not be at least as important a factor in deciding which domestic entities will be funded and on what terms as economic rationale.
My guess is that the CIC will start out investing largely in liquid foreign securities, which responsibility will be handed off to SAFE (State Administration of Foreign Exchange, the body that is responsible for most foreign exchange transactions of Chinese state entities). Given the recent turmoil in the markets and the criticism the CIC has received for the Blackstone investment, I suspect that its first investments will be fairly conservative, although a lot of people are telling the CIC that the market turmoil is an excellent opportunity for a cash-rich entity to find great bargains.
As it grows, an increasing amount of its assets is likely to be invested I strategic investments, which I suspect will include the financing of the foreign expansion of state-owned companies. This may turn out to be the most highly politicized aspect of the CIC’s future business.
With $30-40 billion a month pouring into China’s reserves, it wouldn’t be surprising if a steadily increasing amount of money , either held at the PBoC or at the CIC, is invested in riskier assets and strategies than in the past.It is a little too early to get a bead on exactly how and where this money will get invested, but certainly anything that lifts the Chinese fog should help clarify the global balance of payments. I will try to stay on top of rumors and facts about trhe CIC and PBoC investment strategies, and of course would appreciate comments from anyone that knows anything.
I am not sure I understand why you think that Central Bank Bills are ineffective as a sterlization tool. or why being very liquid makes them ineffective? For arguments sake let's ignore the fact that they try and sell these bills at artificially low rates as I do agree that would cause a problem but only to the extent you can't sell enough to sterlize the amounts you want. If the PBOC sells anything, it contracts the money supply. That is the role of any central bank's balance sheet. The PBOC sells a bill, the asset side of the ledger goes down therefore its net reserve liabilities must go down too. Assuming the bank that bought the bill did not have excess reserves at the central bank then he had to sell some other asset in order to get the money to pay for the central bank bill. You say that these Central bank bills are too similar to cash. What does that mean? Do these bills qualify as reserve instruments? If so, then of course it doesn't work, but that is not sterilization.
On the CIC. Can you clarify exactly what is happening here. It sounds like they have created away for the PBOC to reduce reserves; unsterilized. The government is raising RMB in the marketplace by selling these 10 year CIC bonds. The government then sells the RMB to the PBOC for FX . So the PBOC gets to reduce its FX reserves and see RMB taken out of the market. The FX reserves sold to the Governement is now effectively owned by the new owners of the CIC bonds. These new owners of the CIC bonds have effectively sold RMB and purchased ownership of FX reserves or FX reserve collateral against payment. How much do the new CIC bonds pay anyway?Are they getting above market rates? Bleow market rates?
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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December, 2007
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