China's Sovereign Wealth Fund Turns Inward

For all the Western attention devoted to China Investment Corp.’s big overseas purchases, the sovereign wealth fund’s mandate to trouble-shoot areas of the domestic economy has drawn less interest. But it is this mission that China called upon it to perform this week, specifically, to shore up the country’s distressed stock market, which has essentially wiped out all of the gains achieved over the past eight years.

After taking headline-grabbing, billion-dollar equity stakes in the Blackstone Group and Morgan Stanley (nyse: MS - news - people ) last year, China’s $200 billion sovereign wealth fund will buy shares in three of the country’s biggest state-owned banks, whose shares have more than halved in value this year. The fund will take stakes in Industrial and Commercial Bank of China (other-otc: ICBAF - news - people ), Bank of China (other-otc: BACHF - news - people ) and China Construction Bank (other-otc: CICHF - news - people ) to calm panicked investors amid a global credit crisis, the state news agency Xinhua said Thursday. The move sent all three banks’ shares soaring more than 15% in Hong Kong on Friday.

This inward recapitalization “may not be part of the long-term strategic direction of CIC,” said a Shanghai-based analyst for a foreign investment bank. The move is also a short-term setback, even if a necessary one, for the government’s overall program of partial privatization of state-run companies, some observed.

The desire to reap greater rewards on the country’s trillion-dollar reserves prompted Beijing to create the CIC in 2007. China traditionally invested those reserves in low-yielding U.S. Treasury bonds. But the sovereign fund has been continually called upon to assist domestic state-owned firms.

At its creation in 2007, CIC used one-third of its funds to recapitalize the Agricultural Bank of China and China Development Bank. Now, as shares in ICBC, BOC, and CCB have sunk 58%, 61% and 54%, respectively, on the Shanghai exchange this year, Beijing has been compelled to staunch the bleeding. The steep slide in Chinese stocks has eaten away at corporate profits, for which investment returns are a major source.

CIC’s latest move to buy up stakes in domestic banks signifies “a temporary reversal in the privatization” process undertaken by Beijing, but government officials were being “pragmatic” under “extraordinary” conditions, given the global financial crisis, said the analyst, who asked not to be named. The government has undertaken massive conversions of state-held shares to tradable shares in various state-owned enterprises this year.

After paying $5 billion for a 9.9% stake in Morgan Stanley last year, CIC is reportedly in talks with the Wall Street firm to increase its stake.

In Hong Kong trading on Friday, ICBC shares closed up 65 Hong Kong cents (8 cents), or 16.17%, to 4.67 Hong Kong dollars (60 cents). BOC shares closed up 48 Hong Kong cents (6 cents), or 16.67%, to 3.36 Hong Kong dollars (43 cents). CCB shares closed up 74 Hong Kong cents (10 cents), or 15.74%, to 5.44 Hong Kong dollars (70 cents).