By Michael Lelyveld
As China’s government blocks an increasing amount of outbound investment, it is trying to redirect capital into ventures that further national policy goals.
On Aug. 18, the cabinet-level State Council formalized the curbs on outbound direct investment (ODI) that the government outlined last year, strengthening limits that had been widely ignored.
Last December, government agencies and the People’s Bank of China (PBOC) issued warnings to discourage “irrational” investment in foreign real estate, hotels, cinemas, entertainment, and sports clubs. Such deals would be “closely monitored,” the agencies said.
The joint statement on regulation reflected concerns about capital outflows at the start of this year as foreign exchange reserves dropped below the U.S. $3-trillion (19.4- trillion yuan) mark.
The forex reserves have since stabilized, reaching U.S. $3.092 trillion (20 trillion yuan) in August after modest gains for seven months in a row, the PBOC said last week.
But worries have persisted after last year’s ODI jumped 44.1 percent to a record U.S. $170.1 billion (1.1 trillion yuan), while foreign direct investment (FDI) lagged, growing just 4.1 percent to 813.2 billion yuan (U.S. $125.5 billion).
Threats of closer scrutiny apparently succeeded in slowing capital flight as nonfinancial (ODI) dropped 44.3 percent from a year earlier in the first seven months of 2017 to U.S. $57.2 billion (370.6 billion yuan).
Mixed readings of results
But readings of the effectiveness have been mixed.
Last month, the Communist Party-affiliated Global Times reported that the number of outbound merger and acquisition (M&A) deals rose to a record level in the first half of the year, although the value fell by over 50 percent from a year earlier, according to a study by the PricewaterhouseCoopers accounting firm.
The State Council’s newly-formulated rules for foreign investment are classed under three categories, Bloomberg News said.
Outright bans apply to deals involving core military technology, gambling, sex-related businesses, and investment “contrary to national security,” Bloomberg reported.
Undefined restrictions cover deals in property, hotels, film, entertainment, sports, obsolete equipment, and activities that conflict with environmental standards.
The government will encourage investments in the third category, including “One Belt, One Road” (OBOR) projects to build trade routes through Asia and Africa, those that enhance China’s technical standards, research and development, oil and mining exploration, agriculture, and fishing, the report said.
The broad effort to steer investment into government priority areas is similar to earlier attempts by regulators to draw insurance companies into supporting official initiatives.
Warnings on risk
In July, Chen Wenhui, vice chairman of the China Insurance Regulatory Commission (CIRC), warned insurance companies to take precautions against risks, adding that their funds would be “guided to serve national strategies and interests,” the official Xinhua news agency reported.
In May, a CIRC statement encouraged insurers to invest in government-favored public-private partnership (PPP) projects with state-owned enterprises (SOEs) “to boost the economy.”
The agency said the companies could finance PPP ventures with debt, equity, or a combination of both, according to Xinhua.
The CIRC pledged to speed approvals for PPP investments in projects related to OBOR, development of the Beijing-Tianjin- Hebei region, the Yangtze economic belt ,and the Xiongan New Area development in Hebei province to ease Beijing’s congestion.
In July, the Ministry of Commerce also tried to channel investment into “industrial capacity cooperation,” a government-backed plan to trim bloated industries like steel by moving manufacturing abroad.
“Investment in Belt and Road construction, industrial capacity cooperation and industrial upgrading will receive special support,” spokesman Gao Feng said.
Downturn in activity
Insurance companies have been among the biggest investors in foreign property and hotel deals. But tougher regulation of risks, doubts about financing, and questions of ownership appear to have blunted their bids for big foreign deals.
Among the most frequently cited examples of the downturn in ODI activity is last year’s decision by Anbang Insurance Group to cancel its U.S. $14-billion (90.7-billion yuan) bid for the Starwood hotel chain and pricey Manhattan properties after buying New York’s Waldorf Astoria hotel in 2014.
In July, The Wall Street Journal reported that the government had also ordered state banks to cut off financing for more foreign acquisitions by the Dalian Wanda group after it made high-cost investments in the entertainment industry.
Other major overseas investors reportedly facing tighter restrictions this year have included HNA Group and Fosun International.
Controversy has swirled around ownership of fast-growing companies like Anbang, their political connections, and financial resources, but the larger question is where the diverted flow of ODI is going to go.
Based on the official seven-month figures, China’s nonfinancial outbound investment has dropped by about U.S. $45.5 billion (294.7 billion yuan) so far this year.
Risks at home, too
But some domestic investment opportunities have been actively discouraged, as well.
In 2015, the government warned insurers and financial institutions against speculating in stocks after a bubble burst in the Shanghai Stock Exchange, wiping out small investors.
In February, big investors were again put on notice after regulators denounced Foresea Life Insurance and Evergrande Life Insurance as “financial crocodiles” for an attempted takeover of property developer China Vanke Co. through the stock market despite government calls to reduce risks.
The government’s attempts to safely deflate the bubble in housing prices is also likely to make diverted ODI capital unwelcome there.
But by placing more limits on investment, the government may be narrowing access to opportunities with attractive returns.
On July 31, Commerce Vice Minister Qian Keming claimed a measure of success for the government’s policies, noting that OBOR-related outbound investment fell just 3.6 percent in the first half of the year, compared with 42.9 percent for all of China’s ODI.
Investments in foreign property, sports and entertainment plunged by over 80 percent in the first half, the ministry said.
But the milder drop in Belt and Road investment is hardly encouraging for an initiative that has received such intense official promotion.
The figures suggest that investors’ enthusiasm for foreign acquisitions is not easily transferable to the government- sponsored programs. Officials have not addressed the question of relative risks and returns.
Not much difference
Derek Scissors, an Asia economist and resident scholar at the American Enterprise Institute in Washington, said the risks of OBOR investment are likely to be greater than those that now face restrictions.
“OBOR investment or construction financing is certainly more risky than Western hotels, holding other features constant,” Scissors said by email.
“The key is those other features, principally whether the money is just being rushed out of the country regardless of return,” he said.
Economically, the diversion of outbound investment is unlikely to make much of a difference, Scissors argued, citing the much larger pool of liquidity represented by the broad measure of money supply, known as M2.
“The amount of excess liquidity sloshing around utterly dwarfs the amount of outbound investment. Diverting (U.S.) $40 billion (259.1 billion yuan) or whatever makes no difference when the stock of broad money M2 is something like (U.S.) $3.5 trillion (22.6 trillion yuan) too large,” he said.
“All of this is a function of monetary overstimulus,” Scissors said. “If you engage in years of far too rapid money creation and then are not willing to suffer the pain of monetary contraction, you play endless games of ‘I’m sure we’ve figured out how to direct capital this time.'”
Regardless of the economic impact of ODI diversion, the new rules are a sign that China retains the characteristics of a command economy even as it gains influence on markets abroad.
The government has yet to demonstrate that its controls on investment have reduced financial risks, while the question of comparable returns remains in doubt.