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China Insights: Economics | New restrictions on China's outbound foreign investments

BritCham / CBBC
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What’s going on and what does it mean for UK-China business?
By Rongmin Qin
Sector Lead (China), Financial & Professional Services
China-Britain Business Council
On the evening of 29 November, rumours spread of a draft proposal from the People’s Bank of China (PBOC). The talk was that China was outlining new rules on outbound foreign investment in an effort to reduce capital outflows, which have been applying downward pressure on the renminbi and draining foreign exchange reserves. Not long afterwards, the State Administration of Foreign Exchange (SAFE) issued a short statement saying that it would only clamp down on “fake” transactions while continuing to clear genuine ones. 
In the past few days, those in relevant sectors (investment bankers, legal service providers, company executives) who have stakes in pending or ongoing transactions have become increasingly concerned as they try to assess the real impact of these new, alleged restrictions. 
Some observers have described this as inconsistent policy-making. New, stricter measures could be viewed as a step backwards following the renminbi’s induction into the SDR basket (alongside EUR, USD, JPY and GBP) on 1 October, when the International Monetary Fund determined the renminbi to be a freely usable currency. 
In theory, the PBOC should be reluctant to impose any such restrictions as it has worked hard on financial and capital account reforms over the last few years, and this could be seen as a setback for the PBOC’s efforts. In particular, in August 2015, the PBOC announced the renminbi’s dollar reference rate, which allows the dollar/renminbi exchange rate to trade at a 4% trading band (between -2% and +2%) in relation to the previous day’s trading and overnight market moves in Europe and the US. Under this new system, China could no longer set the reference rate and, therefore, the only way China could curtail downward pressure on the renminbi was to sell dollars from its foreign currency reserves. In fact, by the end of October 2015, China's foreign currency reserves had fallen to USD3.12tn from around USD4tn in early 2014. 
This does not mean it is all doom and gloom. CBBC has leveraged its extensive network in China and after speaking to industry players close to the matter, we see three important issues.
Three key points
First, China has become worried about the quality of its overseas investments. There are concerns over the performance of certain Chinese acquisitions and fears that some investments have been made without proper due diligence. According to data from China’s Ministry of Commerce, Chinese companies’ overseas purchases in 2015 (non-financial outbound investments) totalled $121bn. In the first 10 months of 2016, they surpassed $146bn. In recent years, the increased overseas direct investment and M&A activities have driven up the leverage ratio of many Chinese enterprises, which is also leading to further pressure on the Chinese banking system.
Second, increasingly, deals abroad have diversified, arguably outside of the Chinese companies’ core competencies. Some of these deals may be due to genuine diversification needs. Others have been rushed through to arbitrage the perceived dollar appreciation and renminbi depreciation, as illustrated by the number of deals into “hot sectors” such as video game development, Hollywood studios, real estate and football clubs.  
Third, it is widely anticipated that the dollar will appreciate and the renminbi will depreciate due to very probable US rate hikes in December 2016 and the first quarter of 2017, coupled with Donald Trump’s inauguration in January 2017. The new controls on outbound investment could be viewed as an early precautionary step by the PBOC to insulate against downward pressure on the renminbi and a further drain on foreign currency reserves in the coming months.
No great alarm but new areas of scrutiny
So what does this all mean for Chinese investments into the UK? Well, if the rumoured new restrictions prove to be true, we can expect a longer and more thorough vetting of investment proposals by the National Development and Reform Commission (NDRC), the Ministry of Commerce (MOFCOM) and SAFE. 
Also, according to people close to the issue, the State Council is mostly concerned about outbound mergers and acquisitions worth more than $10bn, and purchases of more than $1bn if the overseas targets are outside the investors’ core business. Furthermore, it is rumoured that state-owned enterprises will not be allowed to invest more than $1bn on a single overseas real estate transaction.
Ongoing and pipeline deals between the China and the UK will remain largely unaffected so long as they fall outside the scale and scope listed above. However, as mentioned above, longer approval processes should be anticipated and factored into overall project planning.
For more information, contact the author at CBBC in Beijing: rongmin.qin@cbbc.org.cn
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