On August 18, Beijing announced new regulations aimed at cutting total outward Chinese investment to curb capital flight and reduce financial leverage. These controls discourage outward investment in peripheral sectors in rich countries, while encouraging investments in commodities and Belt and Road (BRI) countries. The Belt and Road Initiative is a policy directive introduced by Xi Jinping to connect China to countries along the ancient Silk Road through investment and construction.
Chinese President Xi Jinping’s plan to curb financial flight and reduce financial leverage could backfire. REUTERS/Fred Dufour/Pool
The regulations classify Chinese outward investment into three categories: encouraged, restricted, and banned:
Encouraged: technology, manufacturing, commodities projects (energy, agriculture, and mining), and investments that promote the BRIRestricted: real estate, hotels, entertainment, and investments that do not meet the technological and environmental standards of host countriesBanned: core military technology and other investments that may jeopardize national security, gambling, and the sex industry
These regulations, however, may have the unintended consequence of shouldering the Chinese state with a greater financing burden. As is, private companies’ interest in BRI countries and commodities is inconsistent, at best, and these regulations will not make BRI and commodities more appealing to the private sector. Therefore, state-owned enterprises (SOEs) with Beijing’s financial support will unavoidably have to take the lead.
Beijing’s announcement is a belated reaction to the 2016 explosion of outward foreign direct investment. Last year, Chinese overseas investment broke records: growing nearly 50% to reach $170 billion. According to the Chinese Global Investment Tracker, AEI’s unique comprehensive dataset of Chinese outward investment and construction projects, energy led in drawing investments at $24 billion.
But two of the newly restricted sectors, tourism and entertainment, were the bigger story. Investment in tourism soared to $22 billion (from $2 billion in 2015) through big ticket transactions like HNA’s $6.5 billion purchase of a 25% stake in the Hilton Worldwide. Entertainment investment came in at $17 billion.
The rise in large M&A’s in these sectors coincided with a widespread belief that the RMB would fall in value, which encourages capital flight to stronger currencies. The accumulated result: official foreign exchange reserves fell $550 billion in 2016. Since last November, Beijing has taken a series of steps to check outbound investment and stabilize reserves.
But Beijing’s desire to check outward investment in peripheral sectors was evident before these regulations were put in place. In the first half of 2017, investment in tourism and entertainment plummeted, to about $4 billion and $2 billion, respectively. Privately-owned Wanda’s failed $1 billion purchase of Dick Clark productions in March made evident that Beijing was looking to rein in these acquisitions. In that regard, the new restrictions merely formalize what has already happened. On the other hand, for real estate, investment is currently at about $9 billion, still on track to reach the $16 billion it has averaged since 2013, but the August regulations may curb that number.
To date, private companies lack interest and experience in BRI countries. The countries that lead in drawing Chinese investment — the US, Australia, Switzerland, Canada, and the UK — are outside BRI and, from 2014 on, only 20% of Chinese outward investment was in BRI countries. Most Chinese activity under the BRI is engineering contracts, at $171 billion since 2014, which are overwhelmingly performed by SOEs and financed by state banks. More BRI activity means SOEs leading the way.
It is no coincidence that while Beijing is trying to engineer this shift, the share of the private sector in total outward investment fell for the first time since 2011. In the first half of 2017, total private outward investment fell by $8 billion, while total state outward investment grew by $11 billion. This is due primarily to the $40+ billion acquisition of Syngenta by state-owned China Reform Holdings and ChemChina. Syngenta’s acquisition is in line with Beijing’s goal of advancing agriculture technology, but also only exacerbates the financial challenges of a growing role for the state in outward investment.
Despite Beijing’s best intentions, these regulations will not make BRI countries and commodities more appealing to the private sector. The final result could then be the opposite of what was intended: greater financial leverage and risk for the state