Following the flows

In an investment world wallowing in liquidity, China has become the focal point of significant transformations in global capital flows.

Financial investors are crowding into the country with seasoned strategic partners to troll China's choppy acquisition waters. Large amounts of new capital from new regions, notably the Middle East, are also arriving.

In 2006, acquisitions rose by 43% in total value, 22% in number of deals, and 29% in average deal size. Private equity (PE) transaction value surged 108%.

The allure of large and quick gains is drawing institutional capital away from more traditional destinations. Concerns have been voiced, for example, that historically strong earnings of listed companies in New York and London are not drawing the sustained investor support they once did.

Even with the Dow at record levels, the inverted yield curve of bond markets has many analysts predicting weakness in major market equities. At the same time, fund competition is pushing many large-scale investors toward higher risk behavior abroad. China is a promising if edgy choice.

A big part of the inbound story is the individual speculator. Real estate values continue to climb in major cities, even when faced with massive new construction and softening rents. Talk of bubbles in both real estate and domestic equity markets is getting louder, and efforts to close channels of speculation are slow to get traction. The "owned but not occupied" phenomenon continues to grow.

Outward bound

China's significant impact as an exporter has been felt for more than 10 years now. In the coming decade, we will see a similarly unprecedented surge in the country's significance as a global financier and acquirer.

A swelling trade surplus, government tax revenues as well as its state owned enterprise (SOE) and investment earnings have already made China the biggest buyer of US Treasury paper. In 2006, the US Treasury sold US$184 billion in debt and China bought nearly half, more than twice its annual purchases in 2002 and 2003.

Add in the IPO successes of some of the larger state-owned financial entities, and it comes to tens of billions in additional liquidity.

Now the stewards of China's cash wealth are looking for investments that are more diversified, better yielding, and more strategic than US dollar assets. Outbound channels already include a growing program to acquire overseas resources and commercial assets, huge credit lines to support exports, and targeted foreign aid to support trade growth and energy security.

A new kind of investor

So far, little attention has been accorded China's potential impact as a global financier, a new kind of global investor. The first hint of concern came when China National Offshore Oil Corp bid for Unocal, with opponents arguing that the offer was unfairly supported by state funds.

A mounting global debate over what constitutes "fair" investment behavior is the inevitable result of China's basic development model and its rising investment potential.

A key part of all this will be the huge new state fund to deploy foreign exchange, which was announced in March. Modeled on Temasek, China's version has initial funding of US$200 billion, already half of the total value of Singapore's very mature fund. Then there is the Bohai Fund, with its first investments coming from social security monies, a reorientation of the Huijin Fund, owned by China's central bank, and a revitalization of other funds, including the State Council's CITIC.

These new and revitalized investing entities, with markedly Chinese characteristics, are considered by China to be commercial investors. But it would be naïve to think they will not also align closely with broader state interests.

As domestic buyers, the funds will support the government's policy to consolidate and commercialize SOEs, but do so without an unconstrained flow of assets and control into the hands of private owners. They will compete with international funds and banks, and debate will begin as to how marketized China's major enterprises really are.

It is the overseas activities of these funds that are likely to stir the more lively debate, though. Especially if global commodity and property assets continue to inflate, or even bubble, China will be too big a player through these new style investment agents to slip quietly into the fray.