Lehman Brothers | Global Weekly Economic Monitor

ASIA EX-JAPAN: OVERVIEW

China: Growing appetite for foreign assets

Mingchun Sun China’s overseas investments are growing rapidly, which could have both positive and
+852 2252 6248 negative effects on the global economy and financial markets.
minsun@lehman.com
In recent months, news of Chinese firms acquiring foreign ones has become commonplace
(Figure 1). In addition to M&A, Chinese entities have been acquiring foreign assets through
Rob Subbaraman portfolio investment and greenfield FDI. In contrast to firms elsewhere, where outward FDI
+852 2252 6249 aims to exploit local markets or cheap production costs, Chinese firms are investing abroad to
rsuba@lehman.com secure a supply of natural resources, gain access to advanced technology and/or establish
global franchises. We expect a continued rise in China’s overseas investments.
Changes in policy stance
China is encouraging In recent years, massive trade surpluses have put heavy upward pressure on the renminbi
capital outflows and resulted in a rapid accumulation of China’s foreign exchange (FX) reserves. To help
ease a massive balance of payments surplus, the government has begun to relax long-
standing FX controls on capital outflows and encouraged companies to set up overseas
production facilities or take equity stakes in foreign firms. The change is also evident in
policies on inward and outward portfolio investment. Although the government began to
allow foreigners to invest in China’s stock markets via qualified foreign institutional
investors (QFII) in May 2003, it has so far approved a total of only US$10bn of such
inflow. By contrast, qualified domestic institutional investors (QDII) – via which
domestic entities can invest in overseas markets – were first approved in July 2006, but
have already obtained US$47bn of outflow quotas.
The policy has led to These policies have led to exponential growth in overseas investments. Outward FDI
exponential growth in (including greenfield and M&A) tripled from US$7.0bn in 2005 to US$21.2bn in 2006.
overseas investments Portfolio investment outflow quadrupled from US$26bn in 2005 to US$113bn in 2006.
Growing appetite for foreign assets
Chinese banks want to Besides the government making it easier to invest overseas, there are a number of other
enhance their international reasons why firms and households are doing so. Chinese banks, sitting on an abundance
franchises via M&A of cash as a result of their recent IPOs, are strong in terms of market capitalisation but
weak in terms of international presence. They are thus acquiring foreign banks to expand
their international franchises. There has been a wave of M&A deals related to this in the
banking sector recently and we expect more in 2008.
Commodity and technology Rising commodity prices have prompted firms to invest overseas to secure supplies of
sectors are the top targets raw materials such as iron ore and tin. As Chinese firms move up the value-added ladder,
for China’s outward FDI their acquisition appetite is also being driven by an eagerness to gain access to advanced
technology and distribution channels (e.g., recent investments by Huawei and Lenovo).
Households are eager to Chinese households are also eager to diversify their investment risk and enhance returns.
diversify their financial Before 2006, they put most of their financial assets in low-yield bank deposits – 97%, by
assets into overseas markets our estimates. However, the very bullish stock market since 2005 has encouraged
households to make a drastic shift in their financial assets from bank deposits to stocks
and mutual funds. On our estimates, stocks and mutual funds now account for about 18%
of households’ financial assets. As domestic stock prices have risen to very high levels,
some investors are eager to diversify, and have begun to turn their eyes to relatively
cheaper stocks in overseas markets. For example, when a US$4.0bn QDII stock fund was
issued in September, it was oversubscribed and sold out in just one day.
A sovereign wealth fund was To enhance the return on its US$1.4tr FX reserves, which were mostly invested in fixed-
set up to enhance the return income products, the government set up a sovereign wealth fund, the China Investment
on official FX assets Corporation (CIC), in September 2007. CIC is expected to manage US$200bn assets and
will mainly make portfolio investments in overseas financial markets.

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 2
Lehman Brothers | Global Weekly Economic Monitor

Capital outflows should
help offset China’s external
imbalance…
… but may increase
volatility in foreign
financial markets
M&A concentrated in
certain sectors could raise
political concerns
Continued liberalization
would increase China’s
exposure to external shocks
Potential impact
Fast growth in FDI and portfolio investment outflow should help to lower China’s overall
balance of payments surplus, reducing appreciation pressure on the renminbi. However, its
potential impact on the global economy and financial markets is likely to be mixed.
The prospect of massive portfolio investments by Chinese entities into a particular
financial market could increase price volatilities there, perhaps mostly through a
psychological effect. If Chinese households were to diversify 5% of their total financial
assets into foreign assets, this would mean overseas investments of US$130bn. The mere
prospect of a significant portion of this money being invested in Hong Kong helped to
push up the Hang Seng Index by more than 50% between late August and early
November, after the Chinese government announced a plan to allow mainland
households to invest directly in the Hong Kong stock market. In our view, QDIIs, as well
as CIC, are now looking beyond Hong Kong for investment opportunities. Thus the real
impact on any single market should be much less. On the other hand, in light of the
recent turmoil in global financial markets, China’s portfolio investment outflow, as well
as M&A, could provide a cushion for the market.
Outward FDI, including through M&A, should be beneficial to the destination economy
in general, but could raise political concerns if they are too concentrated in certain
regions or sectors. As shown in Figure 1, recent M&A activity has been quite diversified
across regions and most acquisitions have pursued stakes of less than 100% in the target
companies. However, they seem concentrated in financial, commodity and technology
sectors, for the reasons mentioned earlier. If investment by Chinese firms in the
commodity sector accelerates in the short term, it could fuel rises in commodity prices
and trigger a spread of protectionism against China, from trade to investment flows.
In the longer term, continued liberalization of capital outflows is a necessary step toward
full convertibility of the renminbi, even though it will boost China’s exposure to external
shocks. We expect a continued rise in China’s overseas investment, with total capital
outflow exceeding US$190bn this year and US$250bn in 2008 versus US$134bn in 2006.■

Figure 1. Major announcements on Chinese FDI activity since June 2007

Time Acquirer Target of M&A Region Sector Details Amount
Oct-07 ICBC Standard Bank South Africa Banking 20% Share US$5.5bn
Oct-07 CITIC Securities Bear Sterns US Financial 6% Share US$1.0bn
Oct-07 Minsheng Bank UCBH Holdings US Banking 9.9% Share US$200m
Sep-07 Sunward Intl. Machinery HPM Europe SpA Europe Machinery 51% Share EUR2.2m
Sep-07 Shagang Group Savage River Australia Metal 90% Share US$108m
Sep-07 Huawei (& Bain Capital) 3Com US Technology 100% Share US$2.2bn
Sep-07 Jinchuan Group Metals X Australia Metal 13% Share US$26.2m
Sep-07 Minmetals Development NABOOM South Africa Metal ore Exploration Rights US$6.5m
Aug-07 Wanxiang Group AI US Machinery 30% Share US$25m
Aug-07 ICBC Seng Heng Bank Macao Banking 79.9% Share US$583m
Aug-07 Baosteel FMG Australia Metal Joint Venture n.a.
Aug-07 Lenovo Greenfield FDI Malaysia Technology Greenfield FDI n.a.
Aug-07 Nonferrous Metals Mining Greenfield FDI Zambia Metal Greenfield FDI US$220m
Aug-07 Great Wall Computer TPV Technology Taiwan Technology 10.3% Share US$150m
Aug-07 Northern Heavy Industries WANDEOR/NFM Germany/France Machinery Merger n.a.
Aug-07 China Development Bank Barclays U.K. Banking 3.1% Share EUR2.2bn
Jul-07 Lenovo Greenfield FDI India, Mexico Technology Greenfield FDI US$31m
Jul-07 Chinasoft International Hinge Global Resource Hong Kong Technology 100% Share US$45m
Jun-07 China Investment Co. Blackstone US Financial 10% Share US$3bn
Jun-07 CIMC Burg Industries B.V. Netherland Machinery 80% Share EUR48m
Source: Mergers-China, National Development and Reform Commission, Bloomberg, Reuters, Shanghai Securities Daily, www.sina.com.cn, Caijing magazine.

9 November 2007 2
Analyst Certification
The views expressed in this report accurately reflect the personal views of Rob Subbaraman and Mingchun Sun, the primary analysts
responsible for this report, about the subject securities or issuers referred to herein, and no part of such analysts' compensation was, is or
will be directly or indirectly related to the specific recommendations or views expressed herein.

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