China’s yet-to-be-formed state investment agency, which will be used to invest part of its massive $1.2 trillion (Rs49.2 lakh crore) worth of foreign exchange reserves, has made its first investment of $3 billion in US private equity firm Blackstone. As Blackstone’s co-founder Stephen Schwarzman told reporters, “It’s a paradigm shift in global capital flows.”
That’s because China’s forex reserves so far have been managed by the aptly named State Administration of Foreign Exchange (SAFE), which invested the funds mainly in US treasury securities. The Blackstone deal shows that the new investment agency will be far less conservative and will be open to investing in all kinds of assets, including a relatively new asset class such as private equity.
With low yields on US treasuries and a depreciating dollar, it makes sense for any country to try to increase the yield from its huge forex reserves. Reports say the investment agency could be given between $200 billion and $400 billion to manage. That will make it much bigger than the $90 billion or so managed by the Singapore government’s investment agency, Temasek, although it’s well below the corpus of US mutual fund companies such as American Funds ($1 trillion as on 31 March 2007), Vanguard ($990 billion) or Fidelity ($864 billion).
In contrast, the total market capitalization of the Sensex companies is around $225 billion and net FII investments in Indian equities in 2006 amounted to a mere $7.99 billion.
The bottom line: With Chinese forex reserves growing at a quarterly rate of $136 billion, that’s a massive source of additional liquidity into the world’s stock markets, even if half of that money finds its way into equities. (The addition to Chinese reserves is around the same as the new money gathered by all US mutual funds in the March quarter, which was $134 billion). The permanent bulls may be right after all—Chinese buying could lead to even greater heights for stocks across the world.
In fact, US treasury prices dipped and yields on benchmark 10-year treasury notes moved up to their highest in three months on news of the Blackstone deal, on concerns that the Chinese will diversify their assets away from US bonds. It’s also true that Chinese investments in US treasuries indirectly boosts equity prices as it keeps interest rates low. But the link between China and equity markets is going to be far more direct now. More importantly, there’s no reason for China to confine its investments to the US as other markets too will benefit.
The deal also provides a glimpse about how China’s investments are likely to be made. Chinese policy makers have called for the acquisition of strategic assets such as oil fields and raw material sources with the money. China clearly believes that investment in Blackstone is a strategic move, given the firm’s close links with the White House and given the haste with which the deal was wrapped up in time for the the US-China trade talks. In the Indian markets, China’s appreciation of Indian achievements in software may translate into investment in IT stocks.
The new agency will have to be circumspect because news of its buying will be sufficient to move markets. It is not in China’s interest to destabilize the US debt markets either. But there’s no doubt that we now have a very strong new player in global markets, one that could result in a re-rating of markets in which it invests. It’s already being called the world’s biggest hedge fund. The big risk, of course, is that a communist fund may not play by market rules.