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Chinese investments in the United States reached a new record in 2016, more than tripling the previous year’s. However, the pace of investments has begun to cool in 2017, following a crackdown in China on capital outflows.

In reaction to massive capital outflows and the resulting downward pressure on the Chinese currency, Beijing tightened its controls on many outbound mergers and acquisitions (M&A) deals, writes research firm Rhodium Group in a recent report.

In particular, outbound investments in real estate, entertainment, and deals outside investors’ core businesses are now under much more scrutiny, and Chinese investors, wary of having their deals struck down by Beijing, have been more reluctant to bid.

With these recent changes, the pace of newly announced investments in the United States has already begun to slow.

“In the first quarter of 2017, the volume of announced acquisitions fell by 20 percent compared to the fourth quarter of 2016. The combined value of announced deals decreased by about half,” stated the Rhodium report.

Chinese Buying Spree

The investment activity that peaked last year started in 2010, when China relaxed rules on outbound investment for institutional investors in order to expand its political and economic influence abroad.

Since 2010, Chinese companies have invested more than $100 billion in the United States across a wide range of industries, with the real estate and hospitality industries attracting nearly 30 percent of the total.

Capital flight from China skyrocketed in 2016 in particular, with mounting economic problems at home and a devaluation of the yuan.

Last year alone, Chinese firms invested a record $46 billion in the United States. The huge jump in investment was driven by a significant number of mega deals, including aviation and shipping giant HNA’s acquisition of U.S. technology and supply chain company Ingram Micro for $6 billion.

The HNA logo is seen on a building in Beijing on Feb. 18, 2016. (GREG BAKER/AFP/Getty Images)

The HNA logo is seen on a building in Beijing on Feb. 18, 2016. (GREG BAKER/AFP/Getty Images)

And U.S. real estate, which is considered a safe haven, was the biggest beneficiary of Chinese investments. The top deals included Anbang’s purchase of 15 properties from Strategic Hotels & Resorts for $5.5 billion and HNA’s $2 billion acquisition of Carlson hotels.

Foreign direct investment by U.S. firms in China, by contrast, stayed flat compared to previous years, at $13.8 billion. Hence, the gap between Chinese investment in the United States and U.S. investment in China widened dramatically last year, stated the Rhodium report.

U.S. Real Estate as Safe Haven

The easing of restrictions over the past few years allowed insurance companies based in China to invest up to 15 percent of their total assets in offshore real estate.

As a result, U.S. real estate, particularly hotels and office spaces, has become attractive for Chinese insurers seeking high returns and portfolio diversification.

Investment in the U.S. real estate market soared after the stock market crash in China in June 2015. The sharp decline in returns at home led investors like Anbang Insurance, China Life Insurance, and Fosun Group to look for safe havens.

However, since the tightening of capital controls in late 2016, “the pace of real estate investment has slowed markedly,” stated the Rhodium report, “but activity has not collapsed.”

There are few pending real estate deals, including HNA’s acquisition of a stake in Hilton for $6.5 billion. HNA also bought 245 Park Ave. in New York for $2.2 billion, one of the highest prices ever paid for a Manhattan office tower.

Uncertainties Ahead

While Chinese investment in the United States continues, it is unlikely to reach the levels seen in 2016, as Chinese investors are now more cautious, according to experts.

“Up until six months ago, corporate investors from China were aggressively outbidding their rivals in cross-border M&A deals,” said a senior executive at a U.S. private equity firm, who wished to remain anonymous.

But for the last six months, investors have been less active, he said. Transaction volume fell by 12 percent in the United States in the first quarter of 2017, according to the real estate firm Jones Lang LaSalle.

“For the first time in two years, New York has lost its spot as the world’s most traded city. Leading the pack is London, regaining the spot it lost in 2015,” said an Jones Lang LaSalle report released in April.

According to another report by real estate brokers Cushman & Wakefield, Beijing is blocking all deals involving investments of more than $10 billion until September 2017, in an effort to regulate international investments.

In 2016, 62 percent of the investments abroad were over $1 billion. Now, M&A transactions valued at more than $1 billion that are outside Chinese investors’ core businesses, and foreign real estate deals by state-owned companies, are being restricted, leading to the investment lag in recent months.

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The AMC Empire 25 in  New York, on Aug. 23, 2016. (Samira Bouaou/Epoch Times)The AMC Empire 25 in  New York, on Aug. 23, 2016. (Samira Bouaou/Epoch Times)

Chinese investments in the United States reached a new record of over $45 billion in 2016—three times the previous year’s total.

Planned M&A (mergers and acquisitions) activity and the U.S. economic outlook suggest that 2017 may be another boom year. But with the changing political climate, Chinese investment may not be all that welcome anymore.

“Chinese investors are receiving an outsized amount of scrutiny from government regulators. … There are numerous lawmakers in Congress who are pushing for greater scrutiny of Chinese deals, in particular,” said Daniel Rosenthal, associate managing director at the consultancy Kroll. Rosenthal previously worked for the Obama administration, advising the president and national security advisers. 

Rising Chinese investment in the United States over the last five years has increased the number of reviews by the Committee on Foreign Investment in the United States (CFIUS), a federal interagency body that reviews investments for their effects on national security.

Chinese Investments at All-Time High

The capital flow from China to the rest of the world soared in 2016 because of economic problems at home and a devaluation of the Chinese currency. The United States has become the largest beneficiary of Chinese capital flight, according to a report by the research firm Rhodium Group.

“Cumulative Chinese direct investment in the U.S. economy since 2000 now exceeds $100 billion,” states the report.

The number of industries targeted by Chinese investors also increased in 2016. The real estate and hospitality industries accounted for 37 percent of total investment.

Chinese companies were responsible for most of the investment through mergers and acquisitions. Chinese companies also expanded through greenfield projects, where companies build their foreign operations from scratch. But the scale of such projects remained small compared to buying out already established companies.

Investments by Chinese state-owned companies accounted for 21 percent of the transactions, and strategic investments exceeded those with purely financial objectives. 

If the economic circumstances don’t change, Chinese investment in U.S. assets will continue to grow this year.

“The U.S. growth outlook is brighter than in Europe and other advanced economies; and anticipation of further dollar appreciation against the Chinese yuan … increases the rationale for adding U.S. assets,” the Rhodium report states.

In addition, there are $21 billion worth of M&A deals pending involving Chinese companies, and greenfield projects worth a combined $7 billion have been announced, according to the report.

However, political uncertainties in China and the United States may throttle the M&A boom. Beijing recently made it more difficult to get approval for overseas investments, presumably to curb capital outflows.

And in the United States, political and regulatory scrutiny expanded because Chinese investments may present a threat to national security. 

CFIUS Under the Trump Administration

President-elect Donald Trump is widely expected to take a harder position on U.S. national security matters than the Obama administration.

However, openness to foreign direct investment has been a key policy for the U.S. government for at least half a century.

“Every president since Carter has issued a formal statement confirming the United States’ openness to foreign direct investment [FDI]. There are reasons to believe that the incoming administration will continue this policy,” the law firm Covington & Burling LLP stated in a post on its blog.

And it is too early to speculate whether a Trump administration will change the review process or expand the mandates of CFIUS, according to the law firm. CFIUS, chaired by the treasury secretary, is an inter-agency committee that reviews foreign acquisitions for national security threats.

However, there are a few areas that may require some immediate changes.

For example, the Trump administration can expand the breadth of the transactions that CFIUS can review, said Rosenthal.

“CFIUS currently does not have an authority to review greenfield investments. … A company can start up a new business within the United States, and they could hire people from other companies, offer competitive compensation, and slowly build a U.S. company that does things that are sensitive to the U.S. government,” he said.

In addition, CFIUS does not have jurisdiction over foreign investments in foreign companies that sell goods and services to the United States or own American subsidiaries. Under the CFIUS statute, only the president has the authority to block such transactions.

In December last year, President Barack Obama blocked a deal that involved a Chinese company buying Germany’s Aixtron, a leading supplier of semiconductor equipment. Aixtron has a U.S. subsidiary and the merger of these two companies would be a risk to national security, according to CFIUS.

However, it is highly unlikely that the new administration will reopen prior CFIUS reviews unless there is a material misrepresentation, according to Rosenthal.

CFIUS includes representatives from 16 U.S. departments and agencies, including the departments of Justice, Commerce, Defense, Energy, and Homeland Security. And there is a balance of power between economic and security agencies within the committee.

However, the new president’s appointments in these agencies may give more voice to the national security arguments and dampen the voices of economic investment and open FDI, Rosenthal said.

“If Trump appoints assistant secretaries at the various agencies who are inherently more skeptical of foreign transactions, then that could shift the balance toward the national security side.” 

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A teller counts yuan banknotes in a bank in Lianyungang, east China's Jiangsu province on August 11, 2015. (STR/AFP/Getty Image)A teller counts yuan banknotes in a bank in Lianyungang, east China's Jiangsu province on August 11, 2015. (STR/AFP/Getty Image)

Everything seems to be well in China, maybe except for the rising defaults. The currency is up almost a percent against the dollar for the last month and foreign exchange reserves only decreased by $4.1 billion, to $3.2 trillion. Long gone are the months of triple digit reserve drain during the turn of the year.

But underneath the surface the picture may not be as rosy.

“Our preliminary estimate of People’s Bank of China (PBoC) reserve operations suggests that net capital outflows amounted to some $39 billion in July, marking the largest net outflows in six months,” write the International Institute of Finance (IIF) in a report. 

There’s a difference between having enough reserves to meet normal balance-of-payments needs and adequate reserves to defend resident-driven capital flight in a panic.

— Worth Wray, STA Wealth Management

So all the money that China made exporting goods, and then some, just stayed abroad. “We would not want to read much into a one-month pick up in capital outflows but we continue to caution that investor concerns about the policy environment and
pace of economic growth will continue to influence the rhythm of capital flows to China,” the IIF states.

(IIF)

(IIF)

Worth Wray, the chief economist of STA Wealth Management, thinks there is a high risk that outflows could pick up again very soon. His premise is that while Chinese currency reserves are still high in absolute terms, and should be sufficient to finance trade, they will not last long if Chinese citizens lose confidence in the economy and move money abroad wholesale. 

“There’s a difference between having enough reserves to meet normal balance-of-payments needs and adequate reserves to defend resident-driven capital flight in a panic. My point is that the buffers continue to fall and Beijing can’t keep following this policy course forever,” he told Bloomberg. 

He compares the exchange reserves against deposits available in the banking system, made up of the savings of companies and citizens, also called the M2 money supply.

The ratio is now at its lowest level since 2003, according to Wray’s figures. 

“We’ve seen an alarming fall in the ratio over the last few years. It was as high as 27 percent as recently as 2014—when FX reserves totaled more than $4 trillion—but is now closer to 14 percent. That’s well below the [International Monetary Fund]’s advisable 20 percent threshold,” he said.

(Source: Bloomberg)

(Source: Bloomberg)

In other words, while M2 is increasing—deposits in yuan can’t really leave China, it’s the owner who changes hands—because of new loan issuance, foreign exchange reserves are decreasing because citizens exchange the money for U.S. dollars and other foreign companies.

The domestic stock market crash was a watershed moment for Mr Wu’s asset allocation strategy, he said.

—  FT Confidential Research

According to investment bank Goldman Sachs, Chinese residents buying foreign assets made up 70 percent of capital outflows during the last 9 months.

This estimate is consistent with survey data from FT Confidential Research. More than 60 percent said they are moving money overseas because of risk diversification and more than half expect the Chinese economy to slow further. A total of 56.8 percent of respondents said they will increase their investment overseas in the next two years.

(Source: FT Confidential)

(Source: FT Confidential Research)

The survey also confirmed the Chinese tendency to overpay for assets, as almost a third of respondents said they are looking for attractive returns overseas. It seems in their case, it is the return of their money, not the return on their money that counts:

Aaron Wu, a 31-year-old financial worker in Beijing, invested more than A$1m ($770,000) last year in a Sydney apartment and another A$240,000 in Australian shares after losing more than Rmb1.5m on the Shanghai stock market. The domestic stock market crash was a watershed moment for Mr Wu’s asset allocation strategy, he said.

China has tried to counteract this trend by making moving money abroad more difficult and 67.6 percent of the respondents say it has become harder to circumvent the $50,000 limit. 

According to Assia Nikkei review, the PBOC has told banks in a private meeting last month to clamp down in international transactions but didn’t make new regulations official. 

And it’s not just the citizens moving money abroad. Companies, whose deposits are included in the above M2 analysis, are also buying foreign assets to the full extent of the law.

Chinese companies bought a total of 493 foreign firms for $134.3 billion during the first half of the year, according to a report by PriceWaterHouseCoopers (PwC) cited by ChinaDaily. This is an increase of almost 350 percent compared to the same period last year.

Contrary to its citizens, the regime is encouraging companies to take over foreign firms, following the Chinese premier’s Li Keqiang’s “going out” policy.

“The outbound M&A is an irreversible trend in the long term,” Liu Yanlai of PwC states in the report. 

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A man reads a newspaper report that China's central bank announced it will devalue China's tightly controlled currency on Aug. 11, 2015 following a slump in trade, triggering the yuan's biggest one-day decline in a decade. (AP Photo/Andy Wong)A man reads a newspaper report that China's central bank announced it will devalue China's tightly controlled currency on Aug. 11, 2015 following a slump in trade, triggering the yuan's biggest one-day decline in a decade. (AP Photo/Andy Wong)

The more debt the merrier, the saying goes, at least until the party stops and the hangover starts. This is true for the debt situation inside China, as well as for international lending to China. 

According to the Bank for International Settlements (BIS), total cross-border bank lending to China decreased $63 billion to $698 billion at the end of the first quarter of 2016. Over the year, this measure is down 27 percent. 

“Since hitting its all-time high at the end of September 2014, cross-border bank credit to China has contracted by a cumulative $367 billion (–33 percent), with interbank and inter-office activity leading the decline,” the BIS writes in a recent report. 

The total stock of outstanding cross-border bank credit was $27.5 trillion at the end of March 2016. 

This is important because that money is not coming back. Once the loan or debt is paid off, it vanishes and can’t be used to fuel other financial or economic transactions. It is part of the reason why many economies in the world are teetering on the edge of a recession with only bank lending to Western governments balancing out the emerging market credit decline.  

The reduction in bank lending is part of the capital that is flowing out of China by the hundreds of billions, $676 billion in 2015 alone.

International Institute of Finance (IIF)

International Institute of Finance (IIF)

Banks in Hong Kong decreased their China exposure by 4.5 percentage points from 32.8 percent of assets at the end of 2014 to 27.3 percent at the end of 2015, according to rating agency Fitch, the first decrease in a decade.  

International banks are wary of a slowing Chinese economy and a rise in corporate defaults.  

According to rating agency Standard and Poor’s (S&P), China’s credit quality is “deteriorating more quickly than at any time since 2009,” it states in a recent report. S&P downgraded three companies for every company upgraded in the first half of 2016.

Chinese corporates will “come under increasing strain as economic growth slows, industrial overcapacity crimps profitability and cash flow, and an elevated appetite for expansion weakens leverage.”

Claims of international banks of different countries in U.S. dollar trillion (left) and U.S. dollar billion (right) (Bank for International Settlements (BIS))

Claims of international banks of different countries in U.S. dollar trillion (left) and U.S. dollar billion (right) (Bank for International Settlements (BIS))

And international banks don’t want to wait for that to happen. Neither do they want to wait for a sharp devaluation of the Chinese currency. 

“A sharp depreciation of the yuan, which would be the consequence if the [foreign currency] reserves would have to be used to safeguard systematically important entities that do have foreign currency debt. This would be the consequence of a failure to act, a recession and, in the worst case, a financial crisis. Again, something that’s survivable; not the end of the world, but very costly and politically destabilizing,” said Citigroup chief economist Willem Buiter. 

Hugh Hendry, principal at the hedge fund Eclectica is more pessimistic:

“Tomorrow we wake up and China has devalued 20 percent, the world is over. The world is over. The euro breaks up. Everything hits a wall. There’s no euro in that scenario. The U.S. economy, I mean everything hits a wall,” he told RealVisionTV earlier this year.

 Follow Valentin on Twitter: @vxschmid

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Children play soccer on a practice pitch at the Evergrande International Football School in Guangdong Province, China. China aims to build more than 20,000 soccer schools to raise its international standing in the sport of soccer. (Kevin Frayer/Getty Images)Children play soccer on a practice pitch at the Evergrande International Football School in Guangdong Province, China. China aims to build more than 20,000 soccer schools to raise its international standing in the sport of soccer. (Kevin Frayer/Getty Images)

News Analysis

Beijing’s plan to turn China into a global soccer powerhouse has led to several investments in foreign clubs over the past year, despite China’s general controls on capital exiting the country.

With official state backing, Chinese foreign investment into soccer clubs ballooned over the past year. Over ten deals were closed since early 2015 involving clubs in the U.K., France, Italy, and Spain.

The latest deal was announced last week, when a group of unidentified Chinese investors bought A.C. Milan, a participant in Serie A and one of the most successful European clubs in history, from former Italian Prime Minister Silvio Berlusconi. The purchase valued Milan at around $500 million.

The A.C. Milan deal comes merely a month after Chinese retailer Suning Holdings purchased a 70 percent controlling stake for around $300 million in Internazionale, another club in Italy’s Serie A.

In the same month, on June 17, Chinese businessmen Chien Lee, Zheng Nanyan, and a consortium of other investors acquired an 80 percent stake in French Ligue 1 soccer club OGC Nice for an undisclosed sum.

China’s shopping spree over the last year has netted the country a list of Who’s Who of European soccer clubs, including varying stakes in Spanish club Atletico Madrid, English Premier League teams Aston Villa and Manchester City, France’s FC Sochaux-Montbeliard, Czech’s Slavia Prague, and others. The Chinese funding came from a spectrum of sources, including individual businesspeople such as Wang Jianlin, private companies, and state-owned companies such as Citic Capital.

AC_Milan

Milan forward Carlos Bacca (L) fights for the ball with Juventus’ Giorgio Chiellini during the Italian Tim Cup final in Rome on May 21. A group of Chinese investors paid $500 million to acquire A.C. Milan this month. (Filippo Monteforte/AFP/Getty Images)

Uncertain Financial Returns

Depreciation pressure over the yuan has led to rising demand for foreign assets. But as an investment, soccer clubs have traditionally yielded mediocre results.

Soccer clubs in France’s Ligue 1 and Italy’s Serie A both recorded aggregate operating losses for the 2014-2015 year, according to data from Deloitte’s Annual Review of Football Finance 2016.

As an investment, soccer clubs have traditionally yielded mediocre results.

Even the Premier League—which is consistently one of the most lucrative—have seen its profitability shrink last year compared to the year before, although as a whole the league has improved their finances from the decade leading up to 2013 when most clubs were deeply in the red due to wage inflation. The ratio of wages to revenues were 61 percent in the 2014-2015 period, 3 percentage points higher than the prior year, Deloitte noted.

Profits at some of the most successful clubs are often razor thin, as a result of wage inflation and high debt service cost. Arsenal, for instance, recorded a pre-tax profit of only 3.8 million pounds ($5 million) in 2014, while Manchester City had losses of 17.7 million pounds ($23 million), according to analysis from U.K.’s Daily Mail.

With currency volatility surrounding the pound and the euro and downbeat economic climate in the Eurozone, outlook for soccer club profitability is uncertain at best.

For a more tangible comparison, we can look to the stock market. The STOXX Europe Football Index, which tracks public share performance of listed European soccer clubs, has fallen 27.4 percent over the past 5 years. That’s a dismal performance compared to the 45.2 percent gain recorded over the same period for the benchmark STOXX Europe 600 Index.

Playing Sport or Politics?

It’s no secret that Chinese Communist Party leader Xi Jinping is personally a fan of soccer.

China’s State Council issued sports industry reform and development edicts in 2014 that likely became the impetus for recent Chinese investment in soccer both domestically and abroad. In a similar policy document issued March 2015, Beijing called for making China a soccer powerhouse by 2050.

To boost the country’s global standing in soccer, Beijing has set out to build up to 20,000 soccer schools around the country within the next five years, following the success of Evergrande International Football School in Guangdong Province, one of the world’s biggest soccer academies. This summer, Chinese soccer clubs also made headlines by paying huge sums in the transfer market for foreign talent.

As with most business decisions from Chinese organizations, politics is often as important as financial returns. And it’s no different for China’s recent thirst for foreign soccer teams.

Lee and Zheng—new owners of OGC Nice—cited last month “strategic and financial reasons” for their purchase of the French soccer club. Peter Schloss of CastleHill Partners, a Beijing-based sports and media agent consultancy, told Chinese business journal Caixin that Chinese companies investing in foreign soccer clubs often gain from “political and business aspects.”

What type of strategic and political gains can be gained?

For high ranking Chinese business leaders, investing in soccer—both foreign and domestic—is another way to curry favor with China’s leader. Since 2012, Xi has embarked on an “anti-corruption” campaign that has investigated and removed from office scores of senior party and business leaders.

A business leader or company promoting soccer is a show of solidarity with Xi and helps to execute his vision for China as a regional soccer leader.

Perhaps more importantly than personal reasons, exerting control over major institutions in the world’s No. 1 sport has other benefits for the ruling party.

China is keenly aware of the power of arts and culture—and soccer is the world’s dominant sport culture in terms of global reach. Beijing’s control over popular foreign soccer clubs, and by extension its players, is one more way for the party to deploy “soft power” globally, indirectly promoting China’s foreign policies, mollifying the problematic aspects of its international image, and expanding its PR influence.

It’s more evidence that for China, political returns could prove just as valuable as monetary returns.

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An investor watches stock price movements at a securities company in Beijing on June 15. (Greg Baker/AFP/Getty Images)An investor watches stock price movements at a securities company in Beijing on June 15. (Greg Baker/AFP/Getty Images)

 

News Analysis

MSCI Inc. dealt a surprising blow to China last week, by again delaying to add Chinese A-shares in the company’s benchmark index for emerging markets.

The market index provider rejected inclusion of Chinese shares into its MSCI Emerging Markets Index, due to worries surrounding transparency of the Chinese markets and capital controls of regulators.

In the end, it was the correct decision. While China has worked over the last year to improve accessibility and liquidity, MSCI’s decision is a wakeup call. Beijing needs more action, less talk if it wants to be treated like any other capital markets.

Surprised?

MSCI’s decision caught many international banks by surprise, as Goldman Sachs, Citigroup, and HSBC all expected China A-Shares to join the global index this month, with Goldman pegging China’s chances at 70 percent.

But it really shouldn’t have been a surprise to market participants. Last year’s snub by MSCI was announced in June—in the midst of the Chinese stock market bubble—and the Chinese Communist Party subsequently outlined a number of market liberalization measures to meet MSCI’s requirements.

Then the bubble burst and stock markets crashed. Assurances of a free market with minimal intervention were quickly discarded.

Regulators resorted to wide ranging measures aimed to stem the stock market decline last summer, including halting initial public offerings, banning short selling of shares under threat of arrest, forbidding major shareholders from selling any stock, forcing banks and institutional investors to pledge buying more shares, and running editorials in major state media encouraging investors to purchase more shares.

Shanghai

A stock ticker screen in Shanghai shows indices of Shanghai Stock Exchange and Shenzhen Stock Exchange on January 7. (STR/AFP/Getty Images)

Individual high-level government officials also blamed various “foreign political forces” of intentionally orchestrating the stock market crash.

Naturally, global investors were spooked by China’s heavy-handed and seemingly haphazard reaction to market gyrations.

Moving Capital Freely

After the Chinese equities markets stabilized somewhat, China earlier this year promised to curb arbitrary trading halts and increase cross-border funding flow, as part of its concessions to address global investor concerns.

But according to MSCI—which solicits feedback from market participants—investors aren’t yet convinced and need more time to assess effectiveness of these policies and see them in action.

Central to MSCI’s decision are investor concerns around market access and capital controls.

China has been slowly loosening market restrictions since its currency has gained greater acceptance worldwide, and it created a Qualified Foreign Institutional Investor (QFII) scheme to allow foreign firms the ability to access Chinese capital markets.

But the QFII scheme has a quota and a lengthy application process. In a discussion around its June 2016 classification decision on China A-shares, MSCI says many international institutional investors are still awaiting QFII quota allocation monthly after submission their applications.

MSCI says that the mechanism for allowing daily capital repatriation, announced in February, still has not come online as of June.

Other concerns relate to repatriation of QFII proceeds, which China caps at 20 percent of prior year average net asset value. This monthly limit, MSCI says, is a “significant hurdle” for asset managers especially during times of market stress when they are legally obligated to meet client redemptions and withdraws.

China has made a lot of announcements about freeing up its capital markets over the last few quarters. But much of that remains just talk, and some of the newer initiatives haven’t been put in place. For MSCI, Beijing must demonstrate that a robust capital flow system is in place—and functioning as intended—before it can gain confidence of foreign institutional investors.

Future Inclusion No Guarantee

“We believe the delay of MSCI inclusion to some extent reflects [investors’] lack of confidence on the policy transparency and implementation efficiency in China,” wrote UBS Securities in a research report last week. “We think such concerns should gradually ease along with China’s continuous liberalization of its capital account.”

We are still not a free market.

— Zhang Yu, Minsheng Securities Co.

UBS’s opinion may be a bit sanguine. If the major gating issue for global investors is capital mobility, they shouldn’t hold their breaths on a resolution.

Due to anemic economic growth outlook, a weakening yuan, and continued expectation of an interest rate hike in the United States, China is unlikely to loosen capital controls in the near future. In fact, it’s been Beijing’s recent policy to clamp down on capital outflows.

In an article on Xinhua, China’s state-controlled news agency, columnist Zhang Zhongkai wrote that in regards to capital repatriation, “International investors should not hold out for the ‘perfect scenario.’”

“It’s rare, even though not impossible, for a country to further open its capital account when growth is slowing and funds want to leave. Zhang Yu, an analyst at Minsheng Securities Co., said in a Bloomberg interview.

Zhang said this is “An issue much larger than the stock market… We are still not a free market.”

In other words, there’s an impasse which—given the current economic and political situation in China—regulators are not likely to resolve quickly.

The Chinese equity market is huge, with total market cap of $6.9 trillion between Shanghai and Shenzhen. Those are figures that international investors simply can’t ignore. The fact that they are concerned about capital liquidity is an indictment to Chinese Communist Party regulators.

It also means that MSCI made an easy, and correct call.

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The world knows about China’s capital outflows. It also knows China sells U.S. government bonds to support its currency. What many people don’t know: Africa is another victim of Chinese capital flight.
Beijing’s direct investment in Africa fell more than 40 percent to about $1.2 billion until June 2015, according to Chinese commerce ministry spokesman Shen Danyang. According to estimates by the Financial Times dataservice unit fDi Markets, it was worse: Down 84 percent to only $568 million for the expansion of existing projects and also new projects set up from scratch (greenfield).
China has invested heavily in Africa to satisfy its demand for raw materials. Raw materials it needed for an unprecedented building boom over the past 15 years.

“There’s the prospect that the slowdown in China is of an uncertain magnitude and that their demand for commodities, their interest in the merging world, will not be the same as it has been in the past decade,” says Harvad professor Carmen Reinhart, author of “This Time Is Different.”
She says a lot of the financing and investment don’t even show up in official reports. “There’s this layer of lending that was increasing pretty dramatically when China was booming. We have relatively poor documentation of that.”
Because of the home-made Chinese economic problems and capital outflows, they are cutting back on financing and investing in emerging markets.
“Are the emerging markets also having a sudden stop that we haven’t quite gotten our hands around? Is Chinese lending not there in the way it has been for a number of years now, when China was growing so rapidly?”
The good news is: Chinese trade is more important for Africa than investment. China’s trade with sub-Saharan Africa grew from $10 billion in 2002 to $170 billion in 2013, according to World Bank data, much more than the roughly $6 billion in Chinese foreign direct investment of 2014. The bad news: China’s trade is slowing down as well, for the very same reason that the country is not demanding as many commodities as during its building boom. 
The other good news—this time without a caveat—is that other countries keep investing in Africa and are are investing much more. France, for example, invested $18 billion in 2014, followed by Greece ($10 billion), and the United States ($8 billion). 
 

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