The risk that China could decouple from US capital markets can no longer be ignored. That’s an important lesson from this week’s decision by Chinese ride-hailing group Didi Chuxing, under pressure from China’s cybersecurity watchdog, to delist from the New York Stock Exchange and go public in Hong Kong. Kong.
The stakes here were not small. Didi’s $4.4 billion IPO in June was the largest IPO of a Chinese company in New York since Alibaba in 2014.
The move came amid reports that China plans to ban companies from entering foreign stock markets through floating-rate entities, the flimsy legal structures in tax havens that underpinned the US IPOs of companies like Alibaba, JD.com. and Pinduodo.
Beijing’s apparent desire to list Chinese companies closer to home could inflict losses on Western investors as more Chinese companies delist or go private.
Much damage has already been done to the portfolio as a result of Beijing’s attack on major tech companies and leading billionaire entrepreneurs, while the plight of overburdened property developers like Evergrande has added to the pain.
At the same time, the US Securities and Exchange Commission plans to force Chinese companies to delist if they fail to disclose more information about government audits and control over their operations.
The curious thing is that until now capital has been blind to political reality. China continues to attract record amounts of foreign direct investment. A recent survey by the US Chamber of Commerce found that by 2021, 59.5 percent of U.S. multinationals reported higher investment, 30.9 percent more than in 2020. Of manufacturers manufacturing in China, 72 percent had no plans to production to move out of the country over the next three years. So much for deglobalization.
In terms of portfolio flows, US holdings of Chinese stocks and debt securities have increased from $765 billion in 2017 to $1.2 trillion in 2020, aided by the easing of foreign access rules.
This trend has been accelerated by index providers including more Chinese securities in global and regional indices, causing passive funds to automatically increase their exposure to China.
In fact, the Chinese government bond market offers the ultimate happy hunting ground for yield seekers. Last year, 10-year bonds offered income of about 3.5 percent, compared to nearly 1.5 percent on 10-year US Treasuries. With Chinese inflation around 1.5 percent, the real yield is positive, unlike US Treasuries, which live in the shadow of an inflation rate of 6.2 percent in October.
That said, the de facto peg of the renminbi to the dollar and the euro means that Chinese government bonds offer little or no diversification to the official reserve managers who are the main foreign buyers, as dollars and euros are the mainstays of their portfolios. And there must be a question about the durability of the peg. Given the deep-seated problems in the housing market, China relies heavily on exports to drive growth, which may make it tempting to aim for a more competitive exchange rate.
What emerges from all this is that the strategic rivalry between the US and China does not justify cold war analogies. China’s economic model has an extraordinary degree of integration into the global system, far greater than what the Soviet Union had. To the extent that there is war in the capital markets, it is largely confined to the primary stock market.
Nevertheless, there is a good chance that there will be political pressure in the US to curb investment in China. A clear indication is the latest annual report of the US-China Economic and Security Review Commission, an independent US agency.
It points out that China’s nominal financial “opening” is in reality a carefully managed process designed to strengthen state control over capital markets and channel foreign financing to achieve national goals.
The commissioners were further concerned that US capital could help modernize China’s military modernization, facilitate human rights violations or subsidize unfair business practices by US companies.
Does this mean that China is a dead end for investment? I would argue that floating rate entities are a no-no because they offer investors no real ownership rights and no voting rights. China is also a challenging area for environmental, social and governance funds, as the country is the largest global polluter. There are undeniable concerns about human rights. And corporate governance notoriously falls short of the standards of the developed world. But for the rest, it is simply a question of whether the risk is realistically priced in.
Beijing’s common prosperity agenda, its penchant for arbitrary political initiatives and its interventionist behavior in markets clearly call for a discount against the US, Europe and Japan. Many investors believe that the discount is sufficient. Geopolitical risks are increasing, but capital flight is not yet on the agenda.
Unhedged — Markets, Finance, and Strong Opinion
Robert Armstrong dissects key market trends and discusses how Wall Street’s brightest minds respond to them. Sign up here to receive the newsletter straight to your inbox every weekday