China poised to set up $200 bln investment fund

By Alan Wheatley, China Economics Editor

BEIJING (Reuters) - China took a big step on Wednesday towards establishing a fund that will invest $200 billion of the country's $1.2 trillion in foreign exchange reserves in assets around the globe.

The embryonic agency has already spent $3 billion on a 10 percent stake in Blackstone, a U.S. private equity group, as part of a drive by Beijing to earn higher returns by making riskier investments.

Lawmakers started to review a proposal that would authorize the Ministry of Finance to issue 1.55 trillion yuan ($203.5 billion) in special treasury bonds to buy foreign exchange to fund the start-up of the agency, Xinhua news agency reported.

The bond plan, submitted by the State Council, China's cabinet, is almost certain to be approved.

The finance committee of parliament endorsed the proposal and commended it to the full standing committee, which is in session until Friday, Xinhua reported.

It said the tenor of the book-entry bonds would be at least 10 years; the interest rate would depend on market conditions.

Xinhua did not say whether the bonds would be issued directly to the People's Bank of China, which controls China's reserves, or sold in the domestic market with the proceeds used to buy foreign exchange from the central bank.

The latter method would drain cash from the banking system and call for careful management by the central bank to avoid a destabilizing spike in interest rates, economists said.

GROWING UNEASE

China currently invests the bulk of its reserves in safe but relatively low-yielding U.S. bonds.

Officials have cited Singapore's state investment funds as a model for its as-yet unnamed agency, suggesting it will in future be buying stakes worldwide in publicly quoted companies and real estate as well as making private equity investments.

The Middle East is one area of interest.

Dubai and Chinese officials have already begun talks on cooperation between their respective state investment agencies, a senior Dubai executive said on Wednesday.

"The Chinese will be looking at investments that we already have in the Middle East and in Western regions of the world," Yu Lai Boon, chief investment officer at state-holding company Dubai World Group, told Reuters in Singapore.

Investment funds managed by governments control an estimated $2.5 trillion in global wealth, outstripping hedge funds.

The Chinese agency will become one of the biggest such funds, which are coming under growing scrutiny in developed countries whose assets are likely to be on their shopping list.

Clay Lowery, the U.S. Treasury's acting undersecretary for international affairs, called last week on the International Monetary Fund and the World Bank to draft a best-practices guide to monitor the investment policies of sovereign wealth funds.

"It is hard to dismiss entirely the possibility of unseen, imprudent risk management with broader consequences," he said.

Kuwait and the United Arab Emirates set up rainy-day funds years ago in the form of state-owned investment vehicles to manage periods of low oil export earnings. Russia has a fund for future generations, as does Norway.

Germany is especially concerned by the rapid growth of sovereign funds, which Morgan Stanley says could have assets of $12 trillion by 2015, roughly the size of the U.S. economy.

"We are watching closely how state-controlled investment firms from Russia, China and the Middle East buy or sell stakes in companies," Germany's Deputy Finance Minister Thomas Mirow told Handelsblatt newspaper this week.

China has said its investment in Blackstone was crafted in such a way as to allay political suspicions. Its stake was small enough not to need U.S. approval, it surrendered its voting rights and it agreed to keep its investment for four years.

IMF chief economist Simon Johnson said on Tuesday that policy makers must cast a careful eye over state-run funds.

"What is the investment strategy of these funds and what is their leverage? I don't know," he said.

"People are beginning to feel uncomfortable about this."