China is expected to spearhead the global economic recovery. However, its ability to do so might get affected by the low returns being earned by Chinese sovereign wealth funds (SWFs). The SWFs are envisaged as key actors in the coordinated response to be launched across the world for kick-starting global growth. But concerns over their ability to inject funds have started assuming serious proportions.
During the last few years, Chinese and Asian SWFs have been acquiring significant financial assets in industrialised economies. Build-up of the financial crisis saw American and European financial institutions eyeing these SWFs as major sources of funds. Chinese SWFs saw this as a significant opportunity for diversifying portfolios in the US and Euro markets.
China Investment Corporation (CIC) and China Development Bank (CDB) are the two main SWFs picking up Western financial assets. The CIC invested around $8 billion in Morgan Stanley and Blackstone. CDB put in around $3 billion in Barclays. Most of these investments took place last year when the enormity of the current crisis was still to be fathomed. The SWFs viewed acquiring stakes in Western financial institutions as access to key strategic assets. It is not only the Chinese SWFs that felt so. Temasek Holdings and Government of Singapore Investment Corp (GIC) of Singapore invested significantly in Merrill Lynch, Citigroup and UBS. Similarly, cash-rich SWFs from the Middle East?Kuwait Investment Authority and Abu Dhabi Investment Authority?invested more than $12 billion in Citigroup and Merrill Lynch.
Problems began as the sub-prime crisis acquired catastrophic proportions. Prices of shares of financial institutions held by the SWFs dropped sharply leading to heavy erosion in value of investment. Net worth of investments by CIC and CDB in Morgan Stanley, Blackstone and Barclays has dropped between 60-70 per cent. On one hand, the drop in values of US financial assets offers good buying opportunities. But on the other hand, the rapid decline in the values of existing investments makes the Chinese and Asian SWFs wary of further forays.
Concerns over the future of its investments in US financial assets were lately articulated by the Chinese Vice-Premier, Mr. Wang Qishan. At the recent US-China Strategic Economic Dialogue, he urged the US to take measures for ensuring safety of Chinese investments in US. These investments include those by SWFs in US financial institutions. They also include Chinese investments in US treasury bonds. The latter are the chief instruments for meeting the borrowing requirements of the US government. Evidently, the financial turmoil in the US has made the Chinese jittery about the outlook for US assets.
There are several implications of the Chinese concerns. First, erosion in value of portfolios will certainly impinge on China?s ability to finance expansive projects across the region. The constraints won?t be in terms of lower capacities to invest. Deploying resources, given the ample foreign exchange reserves held by China, is not a problem. But diminishing returns from existing portfolios will force careful scrutiny of risk-return perceptions in future projects. This will reduce the scale and scope of future investments. The scope will become narrower as the current crisis assumes graver proportions and returns dip further.
The second implication of the Chinese concerns is the signal received by other countries in the region. For Asian SWFs, China?s appeal to the US to ensure safety of its investments is a serious wake-up call. None of the SWFs are gaining from their existing investments. As they develop cold feet on further investment, the possibility of a coordinated response across Asia for putting a recovery stimulus in the pipeline looks remote.
The situation underlines an interesting development in the global balance of financial power. At the beginning of the financial crisis, many analysts felt that this marks the onset of the final decisive shift in balance of financial power from the West to the East. Indeed, the growing Chinese and Asian ownership of US and European assets did appear to indicate so. Such ownership now appears to be a double-edged sword. With asset values dipping and Asian economies struggling to manage recessions, Asia?s ability to provide a ?big push? to global recovery appears doubtful.
As far as China is concerned, its focus will increasingly shift to maintaining its own economy, rather than nursing the world. Chinese small manufacturers are facing their toughest test of the last three decades. As China comes to terms with the harsh reality of single-digit growth, pressure from the Western world continues to mount for freeing the Yuan. This will be a tough call as Chinese exports are getting hit. Falling exports and low returns on investment do not put China in the most comfortable position for driving global recovery.
The author is a visiting research fellow at the Institute of South Asian Studies in the National University of Singapore. These are his personal views
