China's Sovereign Wealth Fund in Interest Troubles

The China Investment Corporation (CIC) is unique among sovereign wealth funds in that its initial capital came not from fiscal surplus, but from special government bonds. It is now having trouble paying back the huge interest for these bonds. "Regarding the $800 billion fund, the company needs to earn 300 million Yuan every working day." Said CIC Chairman Lou Jiwei.

February 29^th was supposed to be the first interest payment day for the initial special government bonds, which all together total 600 billion Yuan. According to the announcement of the Ministry of Finance (MOF), the annual coupon rate is 4.3%. The bonds�interest should be paid every six months; accordingly, the CIC now needs to pay 12.9 billion Yuan to the People’s Bank of China (PBoC), the holder of the special government bonds.

However, the CIC still hasn’t paid the interest. One of the key reasons is that the CIC’s capital is US dollar denominated while interests on special bonds are paid in Chinese Yuan. Taking RMB appreciation into account, the payments would result in a huge foreign exchange loss, an unacceptable situation for the CIC. 

CIC Deputy General Manager, Wang Jianxi publicly talked about the interest problem on March 3^rd. He said that the CIC was unwilling to talk about this issue. It is now coordinating with the concerned departments, hoping that they will consider the CIC’s long-term development as well as related-regulations.

Wang said that the CIC differed from sovereign wealth funds in other countries, as it is not a capital management company charging management fees regardless of gains or loss for the investment products. He therefore hoped that the company could be treated in a special way according to its present situation. Investment companies may suffer loss as well as make profits, it would be difficult for the company to both repay the interest on a fixed regular basis and still make profits from investments. In doing so even the company’s capital fund may suffer losses. 

The interest needs to be paid sooner or later to provide a clear guarantee to those who invest in the special government bonds. Were the CIC to fail in this regard, the MOF would eventually have to make the payments, and if the CIC can’t yield high enough profits to offset the bonds�interest, it is the MOF, as the bonds�issuer that will face financial losses.

The CIC has already made three major investments. It bought into Blackstone on May 30^th 2007, it invested $5 billion in Morgan Stanley in December 2007 and it invested $100 million in the Hong Kong IPO of China Railway in February 2008. The book loss of its investment in Blackstone has already exceeded $1.2 billion, while that in Morgan Stanley has also reached several hundreds of millions of dollars. Wang Jianxi recently revealed that the CIC has received a sum dividend payment from Blackstone.

The market never believed that the CIC would be able to repay the interest with returns from investments, rather, it was expected that the company would use the dividends from several state-owned banks it invested in to pay back the interest. This scenario became less probable when the CIC did not complete the initial payment.

It is also believed that such a key problem should have been carefully considered at the time of the company’s creation, or before the special bonds were issued. Regardless of this, the CIC seems, at least for now, to be in trouble again.

Losses from overseas investments and exchanges, coupled with the interest problem seem to indicate that the CIC will have to undergo a long, possibly painful learning process before it can reach full maturity.