Today’s media reports that China’s Central Banking Regulator (CBRC) is investigating the domestic banking sector’s exposure to global investments made by several privately owned group companies is another example of direct action being taken by Chinese regulators to address capital outflows and high domestic debt levels.
As we recently reported, Chinese Government agencies are taking steps to strengthen their oversight of overseas investments by Chinese companies. The main considerations behind these policies are:
Mitigating excessive capital outflows, which are having a negative effect on the value of the RMB and;
Reducing financial risks caused by outbound investments that have not undergone appropriate due diligence, and/or that are overly leveraged.
Between September and December 2016, Chinese regulators with oversight responsibility for foreign exchange, banking and state-owned enterprises introduced important policy reforms to address several emerging concerns. These concerns included:
The continuing depreciation of the Chinese Yuan (CNY or RMB) which had fallen approximately 10 percent during 2016 despite attempts to stabilise the currency relative to the USD;
An uplift in the outflow of foreign reserves, with estimated capital outflows of approximately USD 725 billion by Chinese companies and individuals, and;
An increase in aggregate debt which has been estimated by Reuters to now be in excess of 250 percent of GDP, largely domestically sourced to finance capital investment.
China’s foreign reserves reduced from a high of USD 4 trillion in mid-2014 to USD 3 trillion in Feb 2017 and were threatening to further destabilise the economy and divert much needed capital away from China’s domestic capital markets.
Chinese companies have been on a binge of outbound direct investment in the past two years. With over 640 foreign investment deals worth USD 215 billion announced by Chinese companies in 2016, there was heightened concern by the Chinese Government that domestic companies were investing into speculative, non-core and highly volatile assets abroad with insufficient oversight and inappropriately high debt levels.
Investments into real estate, hotels, film, entertainment and sports clubs were among the industries singled out for a tendency for “irrational” overseas investment, according to a statement jointly released by the National Development and Reform Commission (NDRC), the Ministry of Commerce (MOFCOM), the People’s Bank of China (PBOC) and the State Administration of Foreign Exchange (SAFE).
Moody’s recent downgrade of China’s long term local and foreign currency issuer speaks to a number of underlying concerns including rising debt levels, falling productivity and an aging population – all of which will slow the growth of economy. The prospect of slowing growth not only has the potential to force private capital offshore in search of higher yielding investments, but it could also drive speculative capital flight from the RMB based on the expectation of a devaluation of the currency unless steps are taken.
Regulatory leavers pulled
As a result a combination of Chinese regulatory policy leavers were pulled in the 4th quarter 2016: monetary policy and money supply was tightened for Chinese banks, reduced foreign exchange limits and approval processes were strictly enforced and strict overseas investment regulations for state and private companies were introduced.
Some of the key policies enacted include:
SOEs are not permitted to invest offshore into large, non-core business by themselves (a negative list is being developed and will be published) or undertake investments (over $1 billion) in the real estate sector
Private Chinese companies require SAFE approval for payments over USD 5 million and the NDRC must approve foreign acquisitions over USD 10 billion or USD 1 billion if deemed non-core. Offshore dividends exceeding USD 50,000 must also be approved.
For Chinese resident individuals, any cash transactions over RMB 50,000 needs to be reported and only one RMB 50,000 transfer permitted per year.
Efforts to increase oversight and accountability for overseas investments are expected to have an impact on investment flows, particularly for non-SOE acquirers (at least in the short-term) and in sectors which are being targeted for “irrational” overseas investments.
The impacts and what it means for Australia?
It’s too early to understand the full impact or how long these measures will remain in place, but initial observations are that these regulatory changes are biting hard. Official MOFCOM data reports Chinese outbound investment fell 50 percent year on year in 1st Quarter 2017. Approved capital outflows have slowed dramatically, from USD 26 billion in the month of September to only USD 900 million in December 2016 and a total of only USD22 billion for 1st Quarter 2017 (i.e. less than one month’s run rate in 2016).
These reforms have already resulted in a turnaround in China’s foreign exchange reserves, which have increased just under USD 3 trillion in January 2007 to USD 3.05 trillion by the end of May 2017.
With AUD 15 billion invested across 103 deals in 2016, Australia remains a very attractive country destination for Chinese investors as it offers sectors which the Chinese middle class consumer market wants – especially health, tourism, education, food, services and technology. These are among the sectors most encouraged for investment in the Chinese Government’s 13th Five Year Plan.
Australia also has major infrastructure development and investment opportunities needs across rail, ports, road, conventional and renewable power which Chinese SOEs are still permitted / encouraged to bid for, especially where there is a link to Belt and Road initiative.
There are already well over 500 large Chinese companies invested and operating here, many with funds offshore (in Hong Kong or Australia) and who continue to show interest in high quality, large scale investments and projects. We are not seeing a slow-down in Chinese investor investment interest yet, but deal completion activity may be slower in 2017 as a consequence of these reforms.
Chinese companies and individuals are finding the process of moving capital offshore and getting approvals very difficult, slow and very heavily monitored.
The strengthening regulatory oversight and ex ante and ex post risk management of overseas investments by companies should lead to better, more value-accretive transactions for China and host countries, including Australia. Over the longer-term, steps to promote and maintain the quality and sustainability of China’s overseas investments are seen as positive.