Zongyuan Zoe Liu has opted to tackle a big and very important subject in her new book, Sovereign Funds: How the Communist Party of China Finances Its Global Ambitions (Harvard University Press). Liu is a Morris R. Greenberg fellow for China studies at the Council on Foreign Relations (CFR) in New York. China’s sovereign wealth fund is interesting and vital to the rise of China’s economy, as it has both grown significantly in recent decades and is deployed on behalf of the state in line with its political objectives.
Whether you’re trying to understand how China invests and lends overseas or finances large capital projects (that British firms may well be bidding on), figuring out the objectives of the national sovereign wealth fund is important.
Can you give us an idea of the size and relative power of China’s current sovereign wealth fund?
I refer to China’s sovereign funds as sovereign leveraged funds as their ultimate source of capital differs from commodity-based sovereign wealth funds. China is home to one of the world’s largest sovereign funds, China Investment Corporation. CIC’s total assets under management reached about $1.24 trillion at the end of 2022, bigger than Saudi Arabia’s 2022 GDP (about $1.1 trillion). Saudi Arabia was the 17th largest economy in the world in 2022.
Besides CIC, China also has a number of sovereign funds capitalised and owned by the State Administration of Foreign Exchange (known as SAFE). SAFE is the foreign exchange reserves management arm of the People’s Bank of China, the central bank. SAFE does not publish the total assets under management of its various investment funds. Conservatively, I estimate the value to be at least $1 trillion - $1.5 trillion.
It is worth noting that the foreign exchange assets managed by CIC and SAFE-affiliated investment funds are not counted towards China’s official foreign exchange reserves, which now stand at $3.24 trillion.
You analyse China’s sovereign funds by following a research principle: follow the money, find the politics. Can you tell us broadly what politics you find when you follow the money?
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First, most Chinese sovereign funds were not established with explicit geo-economic motivations, nor were they initially created as platforms for global power projections. Crises at home and abroad have shaped and expedited the party-state’s policy changes from focusing on the accumulation of foreign exchange reserves to considering reserve diversification and investment in strategic assets.
Initially, the decision to use China’s FX reserves to create sovereign funds was motivated by domestic considerations rather than by an intention to weaponize China’s FX reserves. These domestic considerations include improving China’s financial security, securing strategic overseas assets, and ultimately supporting China’s development.
For the last two decades, China’s sovereign funds have played a significant role in the Chinese economy, mitigating financial crises and tempering exogenous shocks. They have supported China’s industrial policies by financing the state’s procurement of strategic overseas assets, bankrolling Chinese enterprises’ mergers and acquisitions abroad, and sponsoring the development of indigenous Chinese technology startups. As China’s state-owned capital has gone global, the scope of China’s geo-economic influence has duly expanded.
Second, the ascendance of Xi Jinping to the party’s top leadership position in 2012 and the rollout of the Belt and Road Initiative (BRI)have motivated the party to leverage China’s FX reserves as strategic financial power to advance China’s overseas interests. Since 2013, the party has used FX reserves to replenish China’s policy banks and to establish several new sovereign funds, such as the Silk Road Fund, China-Latin America Production Capacity Cooperation Investment Fund, China-Africa Industrial Capacity Cooperation Fund, and CNIC Corporation.
Last but not least, the evolution of the landscape of sovereign leveraged funds in China has been a process of bureaucratic competition. For example, when China Investment Corporation was launched in 2017, its board was composed of representatives from rival government agencies, including the Ministry of Finance, the National Council for Social Security Fund, the China Securities Regulatory Commission, the Ministry of Commerce, and the People’s Bank of China and its subsidiary State Administration of Foreign Exchange. This complex composition means that the strategic decision-making of the board could resemble a political proxy battle between them as the young CIC tried to form its own identity. CIC’s initial capitalization using China’s FX reserves also publicly challenged the SAFE’s long-established role as the only legal administrator of China’s FX reserves. As the size of China’s FX reserves grew, the PBoC and SAFE responded to these challenges posed by CIC. The SAFE has moved beyond its traditional conservative reserve management approach and has adopted unconventional and aggressive diversification strategies, deploying China’s FX reserves to finance the realization of the party’s ambitions in global markets.
You also argue that China’s sovereign funds are unlike commodity-based SWFs in other countries, and so represent an entirely new class, which you term sovereign leveraged funds. Can you explain the difference between the more traditional SWFs and these Chinese SLFs? How does the Chinese state raise capital for its sovereign leveraged funds, and how does this differ from elsewhere?
Unlike traditional commodity-based SWFs, China’s approaches to leveraging its FX reserves to create sovereign funds do not rely upon natural resource revenues. China’s experience with sovereign funds demonstrates that a state without significant natural resource revenues can take on explicit or implicit leverage to source the seed capital for the founding of what I call sovereign leveraged funds (SLFs). SLFs are a political-economic innovation because they are the product of the state leveraging its financial and political resources, explicitly or implicitly, to make it possible to capitalize a fund without relying upon a high-profit revenue stream such as commodities exports.
Explicit leverage means issuing debt and using the proceeds to capitalize SLFs. This process involves expanding the state’s balance sheet and allowing the government to raise new capital from designated institutions or private markets, to add it to the existing stock of available capital, and to deploy the combined lot via a SLF as investments in risky assets. How the debts are structured and raised, who provides the debt proceeds, and who controls the newly established funds are not only financial issues but also political issues. In other words, the decisions about how the newly issued debt will be underwritten and who will ultimately control the resultant SLF are the product of intensive political negotiation and aggressive bureaucratic competition.The creation of China Investment Corporation (CIC) illustrates the explicit use of leverage over China’s FX reserves. The Ministry of Finance (MoF) issued RMB1.55 trillion special purpose bonds and used the bond proceeds to purchase $200 billion FX reserves from the People’s Bank of China (PBoC) and then to capitalize CIC.
An alternative approach for the state to obtain investment capital is to use implicit leverage to convert existing pools of low-risk capital, or state-owned assets like FX reserves, into high-risk-bearing capital that is subsequently transferred to the management of the SLF. How this process constitutes an increase in the state’s financial leverage can be understood by considering the typical investment made by a SLF. In general, the fund uses its capital to make an equity investment in a target company that is itself internally leveraged—that is, it carries debt on its own balance sheet. The sovereign fund’s equity interest is subordinate to the debt of the target company. The state is implicitly leveraged because the debt of the company is not on the balance sheet of the state, but the state still bears the risk of losing its entire equity stake if the company’s debt cannot be repaid. In other words, the leverage is external to the state’s balance sheet. In this way, the state does not issue any new debt or expand its balance sheet, but it still increases its financial leverage. Both Central Huijin and SAFE-affiliated investment companies serve as examples of how the state takes on implicit leverage and then how political conflict ensues.
Economically, the use of either explicit or implicit leverage over FX reserves decreases the stock of FX assets that can be counted toward FX reserves as defined by the IMF. The most important distinction between the two approaches is the accounting treatment and awareness of its existence among the general public. Regardless of which type of leverage the state chooses when raising capital, the political outcome is the same: it will inevitably precipitate political conflict among those who aspire to control the resultant capital. Implicit leverage is usually a more politically expedient choice because the associated liabilities usually are not recorded in the official accounts.
Can you give us some examples of what China does with its sovereign leveraged funds that affects the economy?
For the last two decades, China’s sovereign funds have played a significant role in the Chinese economy, mitigating financial crises and tempering exogenous shocks. They have supported China’s industrial policies by financing the state’s procurement of strategic overseas assets, bankrolling Chinese enterprises’ mergers and acquisitions abroad, and sponsoring the development of indigenous Chinese technology startups. China’s sovereign funds were also sponsors and investors in China’s first semiconductor investment fund. They have also been used to capitalise China’s policy banks, such as the China Development Bank and Exim Bank of China. Through SAFE-Co-Financing, China’s foreign exchange reserves are loaned to support Chinese firms’ overseas investment in strategic assets, such as mineral resources.
Under President Xi, the party-state has gradually expanded the SLF model, applying it to reform state-owned enterprises (SOEs) so as to update the state’s industrial policy. In November 2013, President Xi laid out his vision for China’s economy for the first time and called for creating “state-owned capital investment companies” to invest in “key industries and fields that are vital to national security and are the lifeline of the national economy.” In effect, Xi’s proposed state-owned capital investment companies are SLFs mandated to focus on financing development in state-prioritised strategic industries, such as civil aviation, energy and mineral resources, nuclear power, and global shipping and logistics.
Xi’s prioritisation of capital management in China’s economic reform – and his use of SLFs as a tool to accomplish this – is not a complete departure from the path of his predecessors. Instead, it reflects the enduring influence on China’s economic policymaking of the dual successes of Central Huijin in stabilising China’s financial system and CIC’s expansion into global financial markets. For Xi’s generation of Chinese Communist Party leadership, the SLFs model provides a ready playbook for expanding the influence of the party-State both at home and abroad.
How has Covid-19 and the apparent economic slowdown in China affected China’s sovereign leveraged funds in the last couple of years, and what prospects do you see going forward?
Some of China’s sovereign leveraged funds suffered losses during the Covid-19 pandemic, the same as many other sovereign funds in the world. For example, CIC’s total assets under managed decreased from around $1.35 trillion in 2021 to $1.24 trillion in 2022. As a result, it lost the title of the world’s largest sovereign fund to the Government Pension Fund of Norway. Nonetheless, China’s sovereign leveraged funds have become a reliable source of arsenal for the Chinese government to deploy and address acute domestic economic challenges. As the Chinese economy struggled to recover in 2023, Central Huijin was deployed once again to boost China’s stock market.
The West’s investment screening has arguably had a more consequential impact on the global investment strategy of China’s sovereign leveraged funds. These funds have evolved and changed their strategies in response to increasingly stringent FDI screening by Western governments. Since 2017, CIC and other Chinese sovereign funds have entered into more partnerships with leading institutional investors in Western countries and have launched several bilateral cooperation investment funds. They have become innovative in establishing partnerships and structuring deals in ways that are more likely to pass regulatory scrutiny so as to invest in strategic assets that would be nearly impossible to obtain.
