China’s outward investment: milestones on a different road

The march of Chinese money around the world continues, with 2016 set to be a year for three milestones. First, annual outbound direct investment (ODI) will cross US$100bn for the first time — in fact it has already done so, according to the Ministry of Commerce, which reported last week that the total for the first seven months was US$103bn, a hefty 62% YoY increase. Second, with outflows surging while inflows stagnate, this will probably be the first year that China’s outbound investments exceed inbound FDI. Finally, the private sector now accounts for half of China’s ODI, up from less than a quarter just two years ago.

These shifts suggest the need for a change in the conversation about China’s international money flows. For years, the main question has been whether stateowned enterprises (SOEs) and their policybank financiers would upset the rules of the international economic order, either by scooping up strategic assets in advanced economies, or by leading a charge for increased Chinese geopolitical influence through channels such as the Belt-and-Road initiative. But the driving force behind Chinese ODI is private-sector investment in rich countries, while the Belt-and-Road in particular has yet to gain traction. The key question now is how long advanced economies will put up with large inflows of private Chinese capital while their own firms continue to be shut out of the fastestgrowing parts of China’s economy.

China’s shift from net importer to net exporter of direct investment capital partly reflects simple financial reality: private Chinese firms have more incentive to put their marginal investment dollars abroad. Returns to capital in China have fallen from stratospheric to more normal levels, and access to foreign technology and markets look attractive. And with the renminbi at risk of continued erosion against a strong US dollar, picking up assets with strong dollardenominated cash flows is a sensible portfolio hedging strategy. This latter factor perhaps explains the tripling of Chinese investment in the US in 1H16, to US$18bn from US$6bn in the year-earlier period.

But the shifting balance between outward and inward flows also reflects a deeply asymmetric investment environment. Despite its reputation as a magnet for foreign investment, China in fact runs one of the most restrictive FDI regimes in the world according to the OECD, and is far more closed than other big emerging economies including Brazil, India and Russia. China is especially unwelcoming to investment in the fast-growing service sectors. Chinese officials love to complain about national-security investment review procedures in the US and Australia: last week they slammed the Australian Treasurer’s decision to block China State Grid’s bid to take control of national power network Ausgrid. But these mechanisms — which generally do not even exist in Europe — review only a tiny handful of sensitive deals, and do far less to curb capital flows than China’s vast array of prohibitions and restrictions.

This imbalance — Chinese firms free to invest as they please in advanced economies, while many foreign firms feel shut out of the world’s fastest-growing big market — is replacing trade and the exchange rate as the biggest irritant in China’s international economic relations. In both the US and the EU, there is pressure to impose some kind of a “reciprocity” standard on Chinese investments. It is not clear how this could work: no one has the leverage to force China to bring its FDI regime up to rich-country levels of openness, and for rich countries to become as closed as China is to foreign capital would be ruinous.

The acceleration of Chinese private corporate interest in the rich world contrasts sharply with the struggles of the vaunted state-led Belt-and-Road initiative to gain ground in the developing world. Ironically, Chinese engineering firms enjoyed a decade of rapidly rising revenues from foreign projects, right up to the moment that the government decreed such projects to be a national priority. Almost at that moment, growth stopped, and revenues have basically flat-lined over the last two years.

The simplest explanation for the slowdown in overseas construction income is the 2014-15 commodity price collapse. Much of China’s foreign engineering work focused on resource extraction—mines and processing plants, and related road, rail and port infrastructure—and the economics of many such projects failed to withstand a halving of commodity prices.

The question is whether the Belt-andRoad initiative can reignite growth. There has been a leap in the value of new construction contracts, to around US$18bn a month in 2015-16, from around US$14bn in the prior two years. This could portend a future surge in revenues, as projects move toward completion and payments roll in.

But the rising gap between contracted and realized revenues invites the suspicion that Chinese firms are responding to political pressure by rushing to sign all sorts of questionable deals, and letting them quietly rot away. Provinces and cities have been assigned Belt-and-Road quotas, and are busy sending delegations abroad to find projects. There is an obvious incentive to sign MOUs to fulfill one’s quota, regardless of whether the projects can be executed or not. For now, it seems that promises of a Belt-and-Road bonanza were premature, and that enthusiasts overstated the ability of new financing channels such as the Asian Infrastructure Investment Bank to offset the dearth of viable new projects.

So instead of fretting whether triumphant Chinese state capitalism will change the nature of the global economy—it won’t— policymakers globally need to focus on ensuring that the largely beneficial flows of private Chinese investment capital aren’t choked off by an understandable but selfdefeating drive for simple “reciprocity.” And they need to keep the heat on Beijing to start seriously hacking away at its absurd and outdated thicket of restrictions on inward investment. The world has avoided an outbreak of trade protectionism; it needs to ensure it doesn’t fall prey to investment protectionism instead.