A New Model for Chinese Overseas Investment
BEIJING – Two Chinese initiatives – “One Belt, One Road” (OBOR) and “International Production Cooperation” – encapsulate President Xi Jinping’s views on overseas investment. Both slogans are supported by development approaches (the former in Eurasia, the latter globally) that signal China’s desire to forge a new model of globalization built on mutual cooperation.
Chinese enterprises are already taking these investment cues seriously. By 2020, China’s overseas assets are forecast to triple, to $20 trillion, from $6.4 trillion today. But moving quickly to invest in overseas projects, while appealing to many, carries great risks – and could mean high debt – if not managed properly. If Chinese companies, both state- and privately owned, are to benefit from the leadership’s new vision, they must learn from past failures, and adapt their priorities for the long term.
One key area where China is trying to refashion its outward investment strategy is in Latin America. In recent years, China has vigorously sought to recast its bilateral diplomatic and economic ties to the region. The publication in November 2016 of the second Sino-Latin American and Caribbean policy document (which followed Xi’s visit to Latin America the same month) has created a unique opportunity to deepen bilateral investment, by placing it in a more cooperative framework. Previous approaches, often backed by risky loans that in some cases turned bad, hurt Chinese investors.
The new policy explicitly encourages Chinese enterprises to work with local businesses in sectors like logistics, electricity, and information systems, and it promotes interaction among business, community, and government leaders. Equally important, the policy also expands the availability of Chinese funding, credits, and insurance to investors. Taken together, this holistic approach is something new for China.
Despite considerable political uncertainty in a number of countries in Latin America, governments the region appear keen to meet China’s reform efforts with changes of their own.
For example, Brazil’s government has promoted an “Investment Partnerships Program” to coordinate investments in the finance and transportation infrastructure sectors. In Argentina, President Mauricio Macri’s government has introduced investor-friendly policies to restore confidence after years of political and economic isolation for the country. And in Mexico, structural reforms to increase competition in the telecommunications and electricity sectors, alongside other policies, have curbed inflation and boosted resilience to external shocks, and are expected to help return the country to a primary budget surplus.
With so many country-specific reforms underway, Latin America can serve as a testing ground for China’s new approach to overseas investment. But policy documents and bilateral agreements are just two components of China’s new “going out” strategy. Chinese businesses must change how they think about and act upon foreign investment opportunities.
The traditional Chinese investment model – mergers and acquisitions – is no longer appropriate, because concentrated M&A activity entails tremendous risk. And, unfortunately, that risk has multiplied in recent years. China’s overseas M&As jumped from 5% of the global total in 2011 to 20% in the first half of 2016, reaching some $13 billion in value. According to data released by China’s Ministry of Commerce, non-financial outward direct investment exceeded $170 billion in 2016, a 44.1% increase from 2015.
This trend has been unprecedented for China, which overtook Japan for the first time last year to become the world’s second-largest overseas investor, behind only the United States. But it has also been poorly thought out. The biggest problem is that such concentrated acquisitions have increased leverage, and a higher debt-equity ratio carries a greater risk of downgrading. Historically, roughly 25% of all enterprises are downgraded after an M&A. Such a scenario would be particularly painful for Chinese firms, given their lack of experience with the significant integration and management challenges that M&As pose for any business.
Given these risks, the most important priority for Chinese firms as they interpret the government’s new vision for overseas investment – whether in Latin America or elsewhere – is to stick to the principle of sustainability. Indeed, “long term” must be the strategic starting point.
The OBOR and International Production Cooperation strategies have a commitment to long-term partnerships at their core, and investments that presuppose many years of engagement will complement both frameworks. Only if the financial base is solid, growth prospects sustainable, and multi-year collaboration in place will an investment support the government’s strategy.
Another priority in considering new overseas investment is to consider fully the goals of “international production cooperation.” The aim here is to encourage the transfer of production capacity to other countries, in order to strengthen the “global industrial chain” in mutually beneficial ways. It is imperative to avoid using direct Chinese investment for the short-term export of production capacity, which would not be in China’s interest – and often not in the recipient’s interest, either.
For most equity investors, the value of any project depends to a large extent on effective post-investment management. Clear rights and obligations must therefore be carefully worked out at the start of an investment, something that has been all but absent previously. After all, an M&A is only the first step on a long road.
As Chinese firms invest overseas – as mine does currently in Latin America – they have a responsibility not only to invest wisely and sustainably for the sake of their companies, but also to integrate their strategies with China’s national investment priorities. Those are not mutually exclusive goals, especially if business leaders adhere to the newly articulated principles of sustainable investment and long-term engagement.Liu Jiahua is a former Deputy Director General of China’s State Administration for Foreign Exchange.
By Liu Jiahua