On the prowl

China's sovereign-wealth fund is back on the acquisition trail

Having kept a relatively low profile after big paper losses on its early overseas investments, China's fledgling sovereign wealth fund, China Investment Corporation (CIC), is hunting for acquisition targets once more. Such a move, combined with the more aggressive expansion plans of other Chinese companies, will reinforce speculation that China aims to exploit the global economic crisis by securing strategic assets at fire-sale prices. In truth, the CIC's agenda is more about seeking solid investment returns while helping the government to diversify China's foreign-exchange reserves. Still, Chinese outward investment will remain controversial.

Comments by the CIC's chairman, Lou Jiwei, in mid-April underlined the firm's renewed appetite for foreign investment. Mr Lou talked in particular of the CIC's interest in cautious expansion into Europe. Most importantly, he said that the economic crisis had changed the investment climate. Not only does the collapse in asset prices mean there are bargains for investors like the CIC, but many potential target firms' desperate need for cash is likely to clear away some objections to Chinese investment (particularly when non-controlling stakes in companies are involved).

This is a marked departure from the CIC's hesitant behaviour in the past half-year, when it avoided high-profile foreign investments. That stance was a response to the intensification of the global financial crisis in September and October last year, which hit the value of the CIC's portfolio. A key part of the fund's mandate is to make reasonable returns on its holdings of China's foreign reserves. But the company has been burned by the financial meltdown--in particular by unsuccessful investments in US financial companies.

Curbed appetite

So what has the CIC been up to? During its apparent hibernation, when many overseas markets were too turbulent to invest in, the CIC concentrated on internal restructuring and on domestic investments. As foreign financial institutions sold stakes in China's largest state-owned commercial banks, the CIC stepped in. The fund began purchasing sizeable quantities of shares in domestic banks from September 2008 and continued to do so into January 2009. According to the state-run China Daily newspaper, the CIC now holds shares worth US$22.5bn in China Construction Bank, US$22bn in the Bank of China, and US$22bn in Industrial and Commercial Bank of China.

The recent shift in focus for the CIC, which was established less than two years ago with around US$200bn in capital from China's foreign reserves, underlines the fact that global financials are now unappetisingly risky. Yet Mr Lou's recent remarks on investing in Europe do not necessarily herald the start of an unrestrained shopping spree. Indeed, the need for large overseas investments is becoming less urgent. The downturn in exports has diminished the importance of rebalancing the country's capital flows--a purpose that the CIC's outward investments indirectly serve. In 2007 and 2008 huge inflows of foreign exchange caused significant domestic liquidity issues, but the size of inflows has fallen off since mid-2008. The Economist Intelligence Unit forecasts that China's trade surplus will contract by more than one-third from US$361bn in 2008 to US$230bn in 2013. Inflationary pressure is also easing. The consumer price index is now in negative territory, and the fading away of the food- and oil-price shocks of early 2008 has also made sterilising foreign-currency inflows less urgent.

With the decline in one of its primary roles, the CIC has taken the opportunity to tighten up its operations, reshuffle staff and move into cheaper and less-risky assets. The company hired Zhou Yuan as the new head of its alternative-investment team in December 2008, in the hope that Mr Zhou's experience with UBS, a Swiss bank, would help the unit to improve returns. CIC's recent pursuit of mining investments--for example, with Fortescue, an Australian iron-ore miner--would also suggest a shift towards a more conservative portfolio, as officials seem to regard mining companies as safer and more consistent with national strategic goals than those in the financial sector.

"Go global" and prosper

Despite the easing of capital inflows, China will continue to have very large foreign reserves, and the CIC's mission will remain to diversify those reserves. As such, its investments will remain potentially controversial. The company is therefore keen to avoid the perception that it is on a mission to take controlling stakes in target companies' management or to buy up politically sensitive natural resources. Mr Lou underlined this in a speech in early April. He also stressed the CIC's adherence to the Santiago Principles, a new set of guidelines for sovereign wealth funds that China helped to draft. Undoubtedly, his efforts to present the CIC as a responsible investor are part spin, designed to reduce foreign opposition to the firm's investment plans. But they also suggest that the CIC will err on the side of making cautious and non-controversial investments for the next few years.

The CIC's low-profile approach contrasts with the more aggressive strategies of industrial state-owned enterprises (SOEs), whose investment bids--such as those in the mining sector--continue to make headlines. The SOEs' bolder strategy is being encouraged by the central government's "go global" policy (also referred to as the "going out" policy), the aim of which is to establish a larger Chinese presence in the international arena. The policy focuses on foreign acquisitions, brand-building and boosting international competitiveness. Chinese SOEs are being attracted by the low valuations of increasingly desperate foreign targets. Zheng Xinli, an influential economist with the Chinese Communist Party's top think tank, said in February 2009 that, with the exception of financial firms, China's SOEs should be bold in making overseas investments, particularly in strategically important sectors such as energy and resources. As international raw-material prices and shipping costs plummet, Chinese policymakers see a rare (and cheap) opportunity for Chinese enterprises to develop new markets abroad.

However, the global crisis swings both ways, and China has not gone unscathed. It seems that many Chinese companies, particularly in export-oriented sectors like high technology and textiles, are reluctant to risk overseas investments. Many have financial problems themselves. Despite the high-profile mergers and acquisitions being inked in the resources sector, a recent survey by a government trade promotion body showed that most firms are actually planning to cut down investment overseas.

Battle of Ideas

Chinese companies are enforcing patents against foreign firms

FOR over a decade Schneider Electric of France has bombarded a Chinese firm, Chint Group, with lawsuits accusing it of copying its technology. But the tables turned on April 15th when the two companies settled an infringement case—with the French firm forking over $23m to Chint. The rich settlement against a foreign firm is a landmark. It serves as a reminder that Chinese companies are just as eager to defend patents as Western firms, and that China’s intellectual-property regime has been tightened in recent years.

Long the workshop of the world, China wants to be the brains as well. The country’s patent office leads the world in patent applications, more than 800,000 of which were filed in 2008. Most are for “petty” patents: middling technology that undergoes minimal review and receives only a 10-year term. Such patents are usually derided by research-intensive Western firms—but Schneider was stung by one that had been issued to Chint. And Chinese firms are increasingly filing “invention” patents that are rigorously scrutinised and receive 20 years of protection, as in the West (see chart). This year Chinese companies are poised to surpass foreign ones in receiving invention patents in China.

With the rush for patents has come an increase in disputes. Since 2006 more patent lawsuits have been filed in China than anywhere else, even litigious America. Most pit domestic firms against each other, but in recent years foreigners have found themselves on the receiving end too. In December Samsung, a South Korean conglomerate, was ordered to pay compensation to Holley, a Chinese telecoms firm. The recent victories and lucrative awards will open the floodgates to more suits, predicts Tony Chen of Jones Day, a law firm.

Intellectual property is relatively new to China. Patents date back to Venice in the 15th century, but Communist China did not allow them until 1985. Since 2006 it has pursued a deliberate policy of gathering as many patents as possible and developing home-grown technologies—not least because Chinese companies pay around $2 billion a year in licensing and royalties to American firms alone, according to America’s Bureau of Economic Analysis.

Chinese firms are also increasingly seeking patents abroad, a sign that they plan to protect their technology when exporting it to rich countries. They won 90 patents in America in 1999 but last year they received 1,225. That is still relatively few—IBM, an American technology giant, receives around 3,000 a year—but it is increasing quickly. Because it takes three to five years to issue a patent, the number issued to Chinese firms is expected to soar soon. The quality of patents issued in China is also improving. Revisions to the patent law that take effect in October strengthen the requirement for a patent’s novelty, bringing it up to global standards. Stronger patents are easier to enforce, opening the door to more lawsuits.

All these trends are important because countries that create intellectual property eventually enforce it as well, explains Dominique Guellec of the OECD. America, it is worth remembering, was the great copyright and patent infringer when it was a developing country in the 18th century

Hindsights

The New Colonialist Power

China's hunger for natural resources is causing more problems at home than abroad

It is not an exaggeration to say China is hungry for commodities.The fact is that it accounts for about twenty (20) per cent of the world's population, but it gobbles up more than half of the world's pork, half of its cement, a third of its steel and over a quarter of its aluminium. Indeed much of its spending, estimated at 35 times as much on imports of soya beans and crude oil as it did in 1999, and 23 times as much importing copper—indeed, to point this out China, as a matter of fact, swallowed over four-fifths of the increase in the world's copper supply since 2000.

But worse is yet to come as China is getting ever hungrier. Although consumption of petrol is falling in America, the oil price is setting new records, because demand from China and other developing economies is still on the rise. The International Energy Agency expects China's imports of oil to triple by 2030. Chinese demand for raw materials of all sorts is growing so fast and creating such a bonanza for farmers, miners and oilmen that phrases such as “bull market” or “cyclical expansion” do not seem to do it justice . Instead, bankers have coined a new word: supercycle.

Not all observers, however, think that China's unstinting appetite for commodities is super. The most common complaint centres on foreign policy. In its drive to secure reliable supplies of raw materials, it is said, China is coddling dictators, despoiling poor countries and undermining Western efforts to spread democracy and prosperity. America and Europe, the shrillest voices say, are “losing” Africa and Latin America.

This argument ignores the benefits that China's commodities binge brings, not only to poor countries, but also to some rich ones, such as Australia. The economies of Africa and Latin America have never grown so fast. That growth, in turn, is likely to lift more people out of poverty than the West's faltering aid schemes. Moreover, China is not the only country to prop up brutish regimes. Witness the French troops scattered around Africa, some of whom recently delivered a shipment of Libyan arms to Chad's embattled strongman, Idriss Déby.

A new nuance or a new Global Power?

China as a power broker could—and should—use its influence to curb the nastiest of its friends, including the governments of Sudan and Myanmar. And from its diplomatic posturing as noticed,it has ceased to resist the deployment of United Nations peacekeepers in Darfur, and is even sending some of its own military engineers to join the force. Wen Jiabao, China's prime minister, has called publicly for democracy in Myanmar—which, even though Chinese officials' understanding of democracy is different to Westerners', is a bold step for a government that claims not to meddle in other countries' internal affairs.


Still, China's hunger for natural resources is creating plenty of problems. Most of them, though, are in China, not abroad.

As a country moves from Light industries to heavy industries.... environmental problems begin.

China is hoovering up ever more commodities not just because its economy is growing so quickly, but also because that growth is concentrated in industries that use lots of resources. Over the past few years, there has been a marked shift from light manufacturing to heavy industry. So for each unit of output, China now consumes more raw materials.

That may sound like a minor change, but the implications are dramatic. For one thing, it has encouraged the sort of foreign entanglements that are now causing China such embarrassment. More worryingly, it is compounding China's already grim pollution. Heavy industry requires huge amounts of power. Steelmaking, for example, uses 16% of China's power, compared with 10% for all the country's households combined. By far the most common fuel for power generation is coal. So more steel mills and chemical plants mean more acid rain and smog, not to mention global warming.

These are not just inconveniences, but also an enormous drag on society. Each year, they make millions sick, cause hundreds of thousands of premature deaths, sap agricultural yields and so on. Pan Yue, a deputy minister at the government's environmental watchdog, believes that the costs inflicted by pollution each year amount to some 10% of GDP.

No fire without smoke

It is no wonder, then, that pollution is the cause of ever more protests and demonstrations. There were some 60,000 in 2006 alone, by the authorities' own count. Some are led not by impotent peasants but by well-organised burghers from Shanghai and Xiamen, a development that must horrify China's rulers. And the potential for even more disruptive environmental crises is great: northern China is already running out of water, and the glaciers that feed its dwindling rivers are melting, thanks to global warming.

The government is aware of these problems, and is trying to address them . It has used this month's People's Congress to raise the status of Mr Pan's agency to a ministry. It has increased fines for pollution, reduced subsidies on fuels and scrapped tax breaks for heavy industry. It is also promoting cleaner sources of power, such as windmills and natural gas. Yet despite frantic efforts to clean up Beijing in time for the Olympics in August, athletes still doubt the air will be fit to breathe. The world's fastest marathon runner, for one, has threatened to drop out of that race because of pollution.

All the government's green schemes are being undermined by an artificial abundance of cheap capital, and by bureaucrats' enthusiasm for channelling it to grubby industries. Chinese banks, with the government's blessing, pay negative real interest on deposits and so can lend to state-owned firms very cheaply. Many of those firms also benefit from free land and pay negligible dividends to the state, leaving lots of money to invest in more dirty factories. Chinese depositors and taxpayers are subsidising the very industries that are slowly poisoning them.

China is bound to consume enormous amounts of raw materials as it develops. But given how polluted the country already is, and how much unrest that pollution is causing,It should be considering on a lot of factors among them, less wasteful development strategy which could be a healthier one.