China Invests Overseas

Chinese outward direct investment has begun to soar upward, making the country the world's fifth-largest exporter of capital at nearly US$60 billion annually. That figure is expected to double in the coming three to five years, according to a new study by the HSBC China economics team, headed by Chief Economist Qu Hongbin.

The magnitude of overseas investment, according to the report, hopefully will take some of the pressure off China's gigantic foreign currency reserves, now valued at nearly US$2.9 trillion, with the expectation that outward investment will match and surpass inward direct investment and double within the next three to five years.

Even though outward investment is skyrocketing, the total remains dwarfed by outflows from other countries. According to the United Nations Commission on Trade and Development, the United States, for instance, recorded foreign direct investment outflows in 2009 at US$249 billion, towards the end of the worst global downturn since the Great Depression. US outflows soared upwards by 31 percent in 2010, according to UNCTAD, although no figure was given.

In some cases, Chinese overseas investment has been met with outright xenophobia. In 2004, an attempt by China's CNOOC oil giant to buy the US energy company Unocal was blocked by the US Congress. The attempt by the Haier white goods maker to buy the iconic Maytag brand was withdrawn after adverse publicity, prompting Haier to slow its overseas acquisition plans. Concerns have been raised by Australian politicians over massive energy purchases. here are concerns that China is turning Burma and Laos into vassal states.

China's ambitions to invest in the world have also started to teach the country a hard lesson – that it can be dangerous, and raise serious political problems. Libyan fighting, for instance, has resulted in attacks and devastation of 27 Chinese construction sites and plants. Since 2009 China has been Libya's top trading partner, according to the Chinese Ministry of Commerce, with total trade of US$6.6 billion. As many as 1,000 workers were set upon by the Libyan army and rebel groups and forced to walk hundreds of miles to get away from the fighting to catch aircraft back to China.

In February 2010, Chinese workers were murdered in Ethiopia. They have faced danger in a large number of other countries, and some of it they caused themselves. For instance, in October 2010 Chinese supervisors shot and wounded 11 workers in a Zambian coal mine. In 2006 security personnel killed five other protesting workers at the Chirambishi Copper Mine after a massive blast killed 49 workers in 2005 and leading President Hu Jintao to urge Chinese businessmen to respect local laws.

Despite the troubles, according to HSBC, "the expansion of China's Outward Direct Investment has been extraordinary, in particular since 2002 when China's government initiated its strategic plan to encourage Chinese enterprises to go global."

That drove up outward investment by more than 20-fold in eight years. By 2008, more than 12,000 Chinese companies and institutions were investing in more than 13,000 foreign companies across 177 countries and regions, according to the report.

State-owned enterprises – China's behemoth SOEs -- account for 67.6 percent of overseas investment, while private companies accounted for a minuscule 0.6 percent. The rest was spread among limited-liability companies, shareholding companies and foreign companies.

Unlike the great Japanese buying spree of the 1980s, China's overseas investment is not built on the ambition to acquire glamorous enterprises like motion picture companies or golf courses. Most of it appears to be directed to filling the enormous Chinese maw for natural resources to drive its manufacturing base, which last year led China to surpass the United States as the world's biggest manufacturing economy.

Chinese outward investment, according to the report, is concentrated in five sectors – leasing and commercial services, mining, wholesale and retail, manufacturing and transportation. Those five sectors cover 90 percent of investment, up from a mere 5 percentage points five years ago.

The key motivations for overseas investment, according to the report, revolve primarily around securing resources. China is now the world's second-biggest oil consumer, accounting for 10 percent of global consumption.

Second, the report says, is the acquisition of technology and brand names to strengthen competitiveness across the globe. Two of such acquisitions were Lenovo's purchase of IBM's laptop business and Geely's acquisition of Volvo. Others haven't worked out quite so well, including the purchase by the little-known Sichuan Tengzhong Heavy Industrial Machinery Co. of General Motors' behemoth, petrol-guzzling Hummer marque, which caused Chinese authorities to put their foot down and void the sale. The Hummer has been branded one of the 30 worst American cars ever built.

Third, according to the report, is the establishment of marketing channels in new markets, creating direct distribution networks to facilitate exports or establishing overseas factories to avoid trade barriers.

Emerging markets remain the top destination for Chinese funds. Overseas direct investment to developed markets accounts for only 7.4 percent of total accumulated overseas investment. Asia attracts 75 percent of the total, followed by Latin America at 12.5 percent, Africa 3.8 percent, 3.5 percent in Europe and only 2.1 percent in North America, a dramatic divergence from Japanese overseas direct investment of the 1980s.

Nonetheless, ODI in Europe skyrocketed by 280 percent in 2009, the last year for which figures are readily available; up by 32-0 percent in North America, and up by 100 percent in Latin America.

Hong Kong actually garnered an overwhelming share – 63 percent in 2009 currency flows and 66.9 percent in 2009 stocks. However, that, the report says, "should be treated as an exception." The funds are directed into leasing and commercial services, financial services and wholesale and retail sales.

"Unlike ODI to other tax haven economies, China's direct investment into Hong Kong is mainly due to its unique position as a gateway to the Asia Pacific region and the world. Aside from being a logistics hub, Hong Kong's developed financial markets and advanced services help Chinese companies establish an international presence, build better regional distribution and marketing channels, and enjoy easier access to the region's financial resources."

Within Latin America, the Virgin Islands and Cayman Islands are the top two destinations, accounting for a combined 11.6 percent of overseas investment and more than 93 percent of total Latin American ODI. The Virgin Island and the Caymans also represent two major offshore tax havens, an indication that perhaps it might pay for Chinese tax authorities to take a closer look at who is investing where.

"What China needs to do next is to acquire better technology and establish a global distribution network for its products, especially in emerging markets, in our view," the authors write. "This means much more cross-border M&A in the coming years. China's banks will accelerate international expansion to facilitate their clients' expansion around the globe, implying surging financial investment in the coming years."