a major policy correction will drive ODI in 2018 after a 2017 slowdown
After a sharp dip in 2017, overseas direct investment (ODI) has resumed growth in 2018. But under an emerging management system, planners will channel it into strategic areas. The state and its banking system will continue to push investments deemed ‘rational’ by commercial and strategic standards, while lawmakers develop rules to manage ODI and protect the interests of rational investors overseas.
leaky tank
The government declared open season on ODI in 2014, ending a requirement that all foreign investments be pre-approved by regulators. ODI surged. In 2015, Chinese outbound investment overtook foreign investment into China for the first time. ODI grew, according to Ministry of Commerce (MofCOM), another 44 percent to some US$170 bn in 2016.
To fuel the domestic economy, China’s state-led growth model subsidises credit. This creates arbitrage opportunities for players with access to state-backed funding such as bank loans, bond markets, and public development and innovation investment funds. In theory, capital controls can keep this fuel in the national tank. But China’s increasing global economic integration allows it to leak into other markets. In a much-quoted 2016 remark, leading economist Yu Yongding 余永定 Chinese Academy of Social Sciences asked how mainland residents buy multi-million dollar homes overseas under the current US$50,000 annual foreign exchange limit.
The State Information Centre, a leading government think tank affiliated to the National Reform and Development Commission (NDRC), warned against bankrolling an overseas gambling spree in reports published in 2016 and 2017. Both state-owned enterprises (SOEs) and private companies were buying up everything from Hollywood studios to Italian football teams. The assets were getting shoddier: yield on overseas investments fell from an average of 10 percent 2013-15 to 8.1 percent, and included dubious bets such as purchases of US real estate at prices above pre-2008 heights. Analysing Japanese ODI during the 1980s, the 2016 report concludes that in a bubble, market incentives could not produce wise long-term investments: Japanese firms hollowed out the economy by moving production overseas; when the bubble burst, they were forced to sell off their unprofitable stakes in overseas entertainment and real estate at fire sale prices, leaving behind a weakened real economy and large debts that contributed to Japan’s ‘lost decade’.
‘Appropriate’ ODI, on the other hand, is a chance to acquire ‘mature technology, excellent management experience, advanced production equipment, and global marketing networks’ from developed markets, while offshoring low-end production and ensuring access to natural resources in developing countries. The problem is that the market is failing to sort the wheat from the chaff. Beijing’s solution is targeted state intervention: cut off cheap credit for ODI, and have economic planners decide which investments are ‘rational’.
red light, green light
In late 2016, the state moved to dam the flood. It threatened limits on ‘irrational’ investment. ODI cratered: volume fell by 52.8 percent y-o-y in the first two months of 2017. Major players who tried to get around limits suffered harsh consequences: using a model called ‘onshore guarantee, offshore loans’, companies like Wanda and Anbang had obtained loans from overseas banks guaranteed by Chinese lenders. With the Chinese bank on the hook for risks, these were effectively onshore loans that used overseas banks as agents. A February 2017 crackdown cut off this form of credit, causing flash crashes in the stocks of the most ‘irrational’ investors, and regulators made an example of Anbang in February 2018, arresting its chair and seizing control of the company.
The days of ‘anything goes’ are over, but authorities promise support for rational ODI. NDRC director Xu Shaoshi 徐绍史 (now retired) said in 2017 that State Council aimed to optimise the flow of investments. It would support upgrading industrial quality, efficiency and structure; Belt and Road activities and capacity cooperation; and high tech industry investments, said Xu. Irrational ODI made by enterprises outside of their core business would, he added, be regulated to guide investment ‘prudently, precisely and rationally’.
In August 2017, State Council laid out an ODI guidance framework, classifying sectors into ‘encouraged, restricted and prohibited’. For the ‘encouraged’, the state is to provide favourable taxation, foreign exchange, insurance, customs and information for investors. For the ‘restricted’ sectors, the state will ‘guide’ investors to ‘participate with caution’.
The state also moved to block public money from going into ODI, promoting instead privately-funded ‘outbound investment funds’. Buyers who are denied certificates have found alternative ways to fund deals through complex financing structures, said Qian Jun 钱军 Fudan University Institute of International Finance. These structures spread risk, claimed Qian, making them appropriate for suboptimal ODI. A prime example is Chemchina’s record-setting US$43 bn deal to buy Swiss agrochemical giant Syngenta.
click image to enlargea matter of national security
Under a tighter regime, ODI has resumed growth. In Q1 2018, Chinese enterprises' investment in 2023 firms from 140 countries and regions shot up to US$25.5 bn, up 24.1 percent y-o-y. 1,867 Chinese enterprises were approved to invest a total US$34.65 bn abroad, 1,861 of which were ODI, accounting for US$33.53 bn.
Eager to see more ODI in strategic sectors, Beijing faces challenges abroad as US, EU, Australia and others conduct increasingly aggressive reviews of foreign investment in national security, basic infrastructure and the high-tech sector. These reviews, states Liu Lifeng 刘立峰 NDRC Investment Institute researcher, are arbitrary and non-transparent. On 26 Jun 2017, a Deepening Reforms Leading Group meeting reviewed ‘opinions on improving the security of enterprises going oversea and outbound investment’, and stressed that the security of overseas enterprises and foreign investment constitute an important part of China’s national interests. When 'rational' investors face trouble overseas, the government will have their back.
relying on the visible hand
The new rules impose an administrative filter on ODI. Bubble bets are to be eliminated, long-term investments sped up. The guidelines encourage investments in favoured sectors like manufacturing, agriculture, energy, advanced technology, medicine, infrastructure projects and resource development; and national geo-economic strategies like Going Global, BRI, capacity cooperation and BRICS.
They do not, however, eliminate the market incentives that drove the ODI boom: as long the state relies on high real estate prices and low interest rates to sustain domestic growth, ODI into higher-interest rate economies will remain tempting. Under these conditions, markets will not allocate resources wisely. While recent reforms seek to give the market more autonomy for now, China will rely on the visible hand of economic planners.
the gatekeepers
Since 2014, China has permitted ODI by default; the state ended an earlier requirement for all overseas investments to be reviewed and has conducted limited post-facto supervision. To prevent ‘irrational’ ODI, the emerging regulatory framework will bring back pre-approval requirements for investments that have certain risk factors or are especially large. Under new implementation rules on overseas investment, which took effect 3 March, projects in sensitive areas must be certified by MofCOM. In non-sensitive areas, central state-owned enterprises (SOEs) and other enterprises with registered capital exceeding US$300 million must report projects to the NDRC or local development and reform commissions (DRCs).
The rules will be enforced by three traffic cops—NDRC, MofCOM and the State Administration of Foreign Exchange (SAFE)—but their roles are still unclear. In theory, the macro-focused NDRC writes the rules, identifying encouraged, restricted and prohibited sectors; while MoFCOM reviews investments in restricted sectors and countries and provides advice and support to investors. SAFE is responsible for authenticy and legality of funds transfers, but delegates day-to-day verification to banks and conducts post-facto oversight.
However, the updated rules mentioned above give the NDRC authority to oversee almost all aspects of ODI activities, and empower it to suspend or terminate deals, suggesting that it will intervene in regular oversight operations. MofCOM also plays a role in rule-making: it has confirmed that it is working on a comprehensive Overseas Investment Regulation, but has not provided details. SAFE has also been used for the macro task of managing overall flows: its January 2017 instructions to banks to restrict capital outflows were the first shot in the ODI crackdown.
Financial regulators are also watching what capital is going to ODI, notes Jia Biao 贾飙 CIRC Insurance Capital Supervision Department vice director. They have moved to stop banks and insurance companies from risky overseas bets, issuing new regulations on their use of capital and penalising insurers who persist in using the ‘onshore guarantee, offshore loan’ back door. These rules also bring development and policy banks, traditionally major sources of ODI funding, under supervision for the first time.
There framework still has large holes, observes Feng Lei 冯雷 China Academy of Social Sciences Financial Strategy Research Institute researcher, with existing regulatory powers scattered among different departments. Expect further measures to flesh out this system in coming months, including MofCOM’s comprehensive regulation. At the 2018 Two Sessions, Nan Cunhui 南存辉 Chint Group chairman and CPPCC member called for developing a top-level and systematic law that protects the rights and interests of Chinese investors abroad.
who is moving the agenda?
Ning Jizhe 宁吉喆 | NDRC vice chairman, National Bureau of Statistics director
Ning supervises NDRC’s Department of Foreign Capital and Overseas Investment, active in policy research, the Belt and Road Initiative and Sino-US economic diplomacy. He also sits on the People's Bank of China Monetary Policy Committee. Ning forecast in 2017 that Chinese outbound investment would total between US$600 to US$800 bn over the next five years, of which a large proportion will be related to the Belt and Road Initiative.
Ning is considered premier Li Keqiang’s most trusted advisor on economic issues. When Li became vice premier in 2007, Ning was deputy director of the State Council Research Office. He replaced a disgraced National Bureau of Statistics director Wang Baoan 王保安 in 2016, launching a nationwide investigation of government statistics. His efforts to deter data falsification culminated in a revised Statistics Law. Ensuring credible statistics, he repeatedly emphasised, is 'the most urgent and important political task'.
Han Yong 韩勇 | MofCOM Outward Investment and Economic Cooperation Department commercial counselor
Previously assigned to trade remedy investigations, Han now leads MofCOM’s work on outbound foreign direct investment, foreign project contracting and international business cooperation. Chinese enterprises, says Han, face political, economic, commercial and legal risks when investing in projects abroad but a MofCOM study last year showed that most are safe and are succeeding in system design, staffing, facility configuration and emergency management. MofCOM will produce innovative policies to protect China’s interests abroad in 2018, he has promised.
Pan Gongsheng 潘功胜 | State Administration of Foreign Exchange director, PBoC vice governor
Pan’s early 2016 appointment as director of SAFE surprised many, given his lack of forex experience (he had been a PBoC deputy governor since 2012). Media noted his English language skills. Pan worked in the Chinese banking sector for two decades, rising to top positions at Agricultural Bank of China and Industrial and Commercial Bank of China before joining the central bank. Known for his international outlook, he advocates for increasing the market’s role in setting interest rates and prices as well as lifting restrictions on capital and current account convertibility. Crackdowns will continue on illegal capital flight, money laundering and tax evasion, while reassuring the public that no restrictions will be placed on normal business profits and dividend remittances.
timeline
11 Apr 2018: NDRC and five other agencies issue 'Opinions on guiding healthy development of outbound investment financing funds'
24 Feb 2018: insurers asked to correct overseas investment activities
23 Feb 2018: China Insurance Regulatory Commission (CIRC) takes control of Anbang Insurance Group and and three major insurers received warnings for violating overseas investment rules
12 Feb 2018: CIRC and State Administration of Foreign Exchange (SAFE) jointly issue notice to restrain insurers’ practice of offshore borrowing with onshore guarantees
11 Feb 2018: NDRC updates ‘sensitive sectors’ list for outbound investment
2 Jan 2018: MoF streamlines ODI-related tax policy
28 Dec 2017: MofCOM issues update of ‘Overseas investment and cooperation country (region) guide’
26 Dec 2017: new NDRC overseas investment rules issued. Rules take effect 3 March 2018
18 Dec 2017: NDRC, MofCOM, People’s Bank of China, Ministry of Foreign Affairs and All-China Federation of Industry and Commerce release regulations for private enterprise outbound foreign investment
15 Nov 2017: CBRC issues first regulatory measures for policy banks
9 Nov 2017: MofCOM issues Notice on improving customs declaration to enhance regulation over outbound investment
26 Oct 2017: MofCOM issues Notice on supervision specifications on outbound investment and cooperation through randomising inspectors and targets and publicising results (trial)
18 Aug 2017: State Council issues guidelines to regulate overseas investments
3 Aug 2017: MoF issues Financial Management Measures for Overseas Investment of State-owned Enterprises
26 Jun 2017: Deepening Reforms Leading Group meeting reviews ‘Opinions on improving the security of enterprises going overseas and outbound investment’
23 May 2017: Deepening Reforms Leading Group meeting reviews ‘Opinions on regulating enterprise operational behaviour overseas’ and noted enterprises' overseas operations should be standardised through an institutional mechanism
26 Jan 2017: SAFE issues measures to encourage capital inflows and tighten outflows
18 Jan 2017: SASAC issues central SOE overseas investment management measures
6 Dec 2016: NDRC, Ministry of Commerce, PBoC and State Administration of Foreign Exchange release statement warning that ‘irrational’ ODI will be closely monitored
29 Nov 2016: SAFE rumoured to have increased capital controls
14 Feb 2016: State Information Centre report argues that government must exercise strong oversight of ODI to manage risks