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The changing narrative on China

"Do you know how big is a billion? Just imagine every person tossing a coin at you at the same time."

This was how one of my flatmates used to light-heartedly describe the scale, the 'massive-ness' of China and its potential market opportunity when I was living in Shanghai back in 2004.

Some weeks back, Mark Mobius, a seasoned investor renowned for his bullishness on emerging markets and China said that he "cannot get his money out".

Mr Mobius' experience might have just come down to a technical glitch in his personal bank account, and the media obviously loves to blow this out of proportion to create headlines.

Capital controls have been existent since China's opening up and reforms decades ago. Everyone who ventures into the country knows and understands this. There are many ways in which flows of capital are designed, structured and moved in and out of China - the VIE structure, SAFE registration, designated cash pools, etc.

That said, earlier this year, the NDRC also published an article guiding the application and use of long-term foreign debt in China. Among other finer details, it states that the process has become more substantive rather than procedural i.e. a more explicit approval is required for companies in China wanting to bring in foreign debt. No more "FYI"s.

To complicate things further, over the last 12 months, SOFR rates - the benchmark for most USD-denominated lending - had risen dramatically, in quite the opposite direction from the PBOC benchmark lending rate. Numerous factors, both macro and on the ground, seem to hint at discouraging the flow of foreign capital to and from the country.

One cannot ignore the nagging feeling that the narrative on China, in spite of its huge market potential, has been changing on a tectonic level.


For years, fund managers have profited from the risk premiums between emerging and mature markets of the world. The business of investing sometimes all simply boils down to simple principles of comparison:

  • All else being the same, money should go to where it has the lowest risk i.e. where it is most familiar

  • The lower the odds of something happening, the higher the expected return. Tails drive everything.

Risk premiums are fundamentally priced off interest rates, a tool used to keep inflation in check; and foreign currency exchange swaps, effectively a measure of how risky one country stacks up against another.

Lately those odds have been somewhat warped: Emerging from the pandemic, one would expect central banks to maintain its near zero-interest rate monetary stance and encourage growth. But the bloating in asset prices happened to quickly and by the time governments intervened, it was too late. China, on the other hand, which was much closed out from the rest of the world during this period, went in an opposite direction.

Short-term dollar-based deposit rates today have elevated to the levels of 4 to 5%, which means investors get compensated with a 5% return just by not doing anything.

Approximately 3-5 years ago, a 5% return was the average expected return for investing in a 'stable market' regime and not doing anything yields anywhere from 0.3% to 0.5%.

Just the arbitrage on risk premiums have compressed so much globally, making it incredibly difficult for many fund managers to justify dollar-based investments in emerging markets. For China, there is an added wrinkle of politics at play.

Last year, the CPC announced slashing the compensation for senior executives at Chinese investment banks. Even state-run financial firms and regulators were not spared either as part of the reforms highlighted at the recent two sessions (两会). Also, last month, Bao Fan, Chairman and chief of China Renaissance, the deal-making rock star of many tech darlings in China, went missing only to re-surface some weeks later with news that he was assisting the authorities with investigations.

One might say that all of this started in Shanghai after Jack Ma's controversial speech in 2020, and also part of China's push for common prosperity. Either way, all of this seems to be the un-intended consequence of "doing well" or achieving outsized returns in China.

If you are facing high cost of funds and still have to contend with limited returns in a regime that is largely state-controlled, it can be really challenging to drive that equity story home. The billion-people market opportunity obviously doesn't sell as well as before.

Embracing policy is a choice for investors offshore but a necessity for firms operating in China. That said, ultimately one just needs to be a believer. A believer in the policies and directions set forth by the incumbent few who are in power, and possibly a lot of faith, something which happens to be incredibly difficult to come by these days.


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