China's shopping spree

China's attempts to acquire stakes in overseas companies such as Rio Tinto and OZ Minerals are part of a wider strategy to expand its reach and diversify its investments. But the shopping spree is not without political risks.
As China shifts out of panic mode and into a more stable crisis management mode for dealing with the global economic slowdown, Beijing is reviving plans to expand resource acquisitions abroad while looking to diversify investments made with its massive foreign currency reserves. Although the domestic Chinese economy remains troubled, Beijing is seeking to take advantage of the global slowdown to expand Chinese interests abroad while prices are low and countries and companies are eager for capital. It is a long-term strategy intended to give China a stronger, more secure position as the world economy recovers, but it is not without political risks.

Over the past several years, China had encouraged its energy companies to branch out overseas and acquire resources via joint ventures or purchases of oil and natural gas fields. Chinese firms were active or advancing in Africa, Southeast Asia, Latin America and Central Asia. As with most Chinese resource acquisitions abroad, these were less about Chinese firms exploiting resources and selling them on the open markets than about controlling access to resources from the ground to the Chinese facilities. In part, this was meant to bypass potential disruptions in international supplies pricing by giving China control from top to bottom, minimising the potential for any external interferences.

The rise in Chinese consumption of resources (particularly commodities like oil, steel and other metals) left China increasingly at risk from market fluctuations and prices – something China tried to combat by diversifying its sourcing to reduce overdependence on any single source. A sharp rise in commodity prices from the end of 2007 through the first two quarters of 2008 tested the Chinese government’s ability to keep up with domestic subsidies – particularly in refined oil products – and triggered rising inflation.

As Beijing struggled with these issues, it also had to face a new problem: the US housing crisis was hammering the Chinese foreign exchange fund’s investments in US financial and investment houses. The combined economic stresses, and the fear that the United States was heading for a deeper economic crisis of its own that could ripple outward, triggered a near panic among Chinese leaders, and the Politburo held a special session in July 2008 that stopped the appreciation of the yuan and unofficially stemmed overseas acquisitions by Chinese energy and resource companies – knee-jerk reactions to the fear of further fluctuations.

Chinese energy and resource firms met these measures with disdain, as the moves interfered with the firms’ long-term plans to try to compete with international oil majors and squelched their growing sense of independence from Beijing’s political directives. Contrary to the position of many other international firms, these Chinese companies felt confident that Chinese banks would continue to back them, particularly as Beijing began loosening credit policies to prevent a liquidity crisis from catching on. By the fourth quarter of 2008, the government had reversed banking restrictions and loosened up credit for overseas acquisitions and mergers. Now, as the Chinese government’s sense of panic has wound down and Beijing has shifted to crisis management rather than abject fear, the government has begun to actively promote these overseas acquisition policies.

With the Chinese already taking steps in the third quarter of 2008 to reverse tight lending policies and other measures designed to slow their economy, Beijing felt more confident when the broader economic crisis struck the United States and spread overseas. China was one of the first countries to announce a massive stimulus plan, unveiling a 4 trillion yuan ($US586 billion) package November 9, and the government began to see opportunities emerging for China from the US and global crises. In many of these cases, the government was overly optimistic. Chinese officials and media began speculating that the Chinese economy not only would weather the economic crisis, but would be somehow more immune to it than other economies, and that Chinese consumption would lift the rest of the world out of the doldrums.

This sense of China’s centrality as the leader of global economic recovery triggered other speculations, ranging from discussions of whether it was time to encourage the use of the yuan as an international currency to expectations that, when the world got together to redraw the global financial architecture, any new Bretton Woods-type meeting would have China as a prominent player at the table — a table perhaps dominated by only Beijing and Washington.

While many of these dreams were a bit beyond the realm of reality, Beijing is once again seeing potential opportunities it can take advantage of in the international markets. Some of this is just an extension of China’s long-recognised need to diversify its economic connections. For years, China has been looking for ways to reduce its oversubscription to US Treasury securities, for example, to expand its resource base and to expand its markets beyond its still-heavy dependence on the United States. And Beijing has tried to encourage a way to boost domestic consumption to reduce the overdependence on exports. These are not new ideas for the Chinese, but they are now seen as opportunities to be snatched up.

Factionalism and differences of opinion abound within the Chinese leadership, as with any leadership. But the current situation has led some to try to convince those who have entrenched interests in the status quo, or who are reticent of change, that China must act now or remain weak and vulnerable. This is a long-term opportunity opening up, they argue; the world is struggling, and China is sitting on a nearly $US2 trillion stack of cash in the form of foreign currency reserves. China has the liquidity others are craving, and with commodity prices low amid the economic slump, there is an opportunity to leverage China’s cash to grab up resources across the globe at bargain-basement prices and on Chinese terms.

Beijing is already backing these moves. It backed the Aluminium Corporation of China’s (Chinalco) decision to invest $US19.5 billion in the British-Australian Rio Tinto (a deal the Chinese company had long been eyeing), and China Minmetals Corporation’s offer for a $US1.7 billion investment in Australia’s OZ Minerals. In addition to backing Chinese companies, the government is looking at taking a more direct role in foreign acquisitions. The China Investment Corp. has begun to focus heavily on future acquisition of resources and other concrete investments rather than on financial investments abroad, having already been burned by the US housing crisis.

And Beijing is using the China Development Bank (CDB) to gain new resources in return for loans abroad. The CDB is in final negotiations with Brazil’s Petroleo Brasileiro SA (Petrobras) to loan the company some $US10 billion for deepwater energy development – a loan to be repaid in oil. A similar deal was inked recently in Russia, with the CDB offering a $US15 billion loan to Rosneft and a $US10 billion loan to Transneft for the completion of an oil pipeline from the Eastern Siberian oil fields to China – with part of the loan repayable in oil.

But Beijing is looking at more than just the acquisition of new resources on the cheap. It also sees the potential to gain leverage through imports from select countries, and the potential to gain market share for exports in the developing world through a policy of loans and aid programs. For example, Chinese Vice President Xi Jinping, on a tour of Latin America, is offering countries additional infrastructure development assistance – with projects carried out by Chinese construction companies, of course. This sort of activity, also used by Japan and South Korea in the past, keeps Chinese businesses active, absorbs some of the surplus raw materials China has stockpiled and can increase consumption of Chinese goods and services. This in part explains the series of high-level Chinese official visits abroad in recent weeks.

In the long run, Beijing hopes to use its ready capital to expand its overseas markets and buy the good graces of countries around the globe, increasing Chinese political influence at minimal cost. And with China one of the only countries out there buying, Beijing is also trying to use the economic slump to encourage Western nations to ease technology transfer restrictions. As the only consumer, China figures it can use its leverage to break down barriers on dual-use technologies, which will bring China short-term benefits from the technologies’ direct applications and reduced development cycle, as well as longer-term gains via reverse engineering.

All of this is not without risks. While China is being referred to as a "lender of last resort” and the only place to go to get cash right now, that "popularity” can also quickly be seen as exploitative. Already, Australian parliamentarians are issuing calls for the review of the approval of the Chinalco deal, raising concerns that it is a strategic acquisition by a foreign government. China’s rush to buy up resources, allies and markets faces charges of imperialism on an epic scale, bottom-feeding and taking advantage of the downtrodden. If commodity prices pick up as economies begin to get back on their feet, and China is no longer the only game in town, a backlash could be in the works.

This could present a new dilemma for China several years down the road. If resistance rises and challenges China’s resource supplies, Beijing will have to decide whether to try to pump more money into governments to buy them off and quell opposition, or to begin to intervene more directly to preserve Beijing’s economic interests – perhaps through funding forces aiming to overthrow governments, covert action or even direct intervention. China is trying to guarantee itself a place at the big boys’ table, but that could come with more political complications than Beijing bargained for.

Stratfor provides intelligence services for individuals, global corporations, and divisions of the US and foreign governments around the world.

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