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Next Steps For ODI

By Le Xia, Chief Asia Economist, BBVA

Mainland China’s outbound foreign direct investment (ODI) saw a big turnaround as its strong growth momentum in 2016 – which reached 49.3% for non-financial ODI flows – came to a halt last year. This is mainly due to the authorities’ restrictive measures to curb capital outflows. In particular, the National Development and Reform Commission (NDRC) formalized the regulatory pathway for ODI transaction approval in August 2017 to classify outbound investment into three groups: encouraged, restricted and prohibited transactions.

The encouraged group includes the areas which are important to the country’s growth and development such as infrastructure projects related to the Belt and Road Initiative (BRI), high-tech business, advanced manufacturing, and research and development. Meanwhile, the restricted group includes deals related to real estate, sports clubs, hotels, entertainment and the film industry. Moreover, overseas investment in gambling or sex industries is strictly prohibited.

These tightening measures have proved to be effective. Since August 2017 there have been no recorded Chinese acquisitions in property, sport and entertainment. Meanwhile, the share of ODI in the commodity and energy sectors started to rise. Investment in these sectors accounted for 49.4% of total ODI flow in 2017, way above 29% in 2016.

Although the decline of ODI is broad-based, the government has continued to stress its determination to press ahead with its new national BRI strategy, with the Mainland’s ODI flow to the 65 BRI countries remaining broadly flat in 2016 and 2017. Accordingly, the share of investment to BRI countries increased to 12% of total ODI from 8% in 2016.

The authorities’ newly selective stance on overseas investment has led state-owned enterprises (SOEs) to outperform their private peers, as many of the former’s overseas investment projects are tied to the government’s favoured BRI strategy. Moreover, their dominance in international construction projects can give them more opportunities to make investments related to construction.

However, the ODI of Chinese SOEs may be substantially aided by concessionary financing from state controlled banks, which has increasingly caused foreign concerns over the fairness of the playing field.

Looking ahead, a number of tailwinds and headwinds have emerged to shape the pattern of Mainland China’s ODI going forward.

Encouragingly, many foreign countries’ views towards overseas investment have somewhat improved over the past two years despite the rise in populism around the globe. Our research has found that the evolution of media sentiment regarding Chinese investment in infrastructure improved in most countries in 2017 compared to 2015.

Adding to the tailwinds are some government-led initiatives. Under the BRI, China created a US$40 billion Silk Road Fund to boost infrastructure investment. Additionally, Beijing spearheaded the creation of the US$50 billion Asian Infrastructure Investment Bank (AIIB) and the US$50 billion BRICS New Development Bank.

In 2015, the country also set up two funds earmarked for its cooperation with Latin America – the China LAC Industrial Cooperation Investment Fund and the China-Latin America Infrastructure Fund. ODI flows to these regions will be greatly aided by improved economic integration and financing for infrastructure investments. Latin America is another region that is bound to receive more ODI on the back of new bilateral lending and investment deals.

However, headwinds to Mainland China’s ODI exist not only at home but also abroad. Anti-globalization movements have intensified in recent years and the international environment has become increasingly uncertain.

The United States has expressed increasing concern about Chinese attempts to acquire technology. The European Union has unveiled proposals of a new framework to screen foreign investments to avoid hostile takeovers in some sensitive sectors; this idea was pushed by France and supported by Germany and Italy. More recently, Australia said it plans to tighten rules on foreign investment in electricity infrastructure and agricultural land, amid concerns about growing Chinese influence in business, politics and society.

In the future, despite the uncertain global environment, outbound investment by Chinese firms is likely to rise over the long term, due to the authorities’ efforts to boost BRI projects and its support of overseas acquisitions that allow Chinese firms to acquire advanced technology and strategic assets.

Continued growing investment and trade links between Mainland China and BRI countries are expected amid connectivity improvements in the next few years. The country’s various industrial sectors will benefit via government-backed entities and, to a lesser degree, multilateral entities. These government-led initiatives will help to improve economic integration and expand the market for Chinese goods and services overseas, all of which will open opportunities for Chinese companies abroad.

Supported by discount financing, immediate beneficiaries will be seen in sectors such as engineering and construction, survey and design, railway signalling systems and rolling stock, as well as in steel machinery and aerospace and defence exports. Over time, we expect operators of ports, railways and other infrastructure to gain from higher volumes initiated by increased bilateral trade between Mainland China and BRI countries. Moreover, mining, transportation infrastructure, manufacturing and information transmission sectors will also benefit.

The industry growth driver for the Mainland’s ODI will move from the property market, hotels, and entertainment to the infrastructure sector, and SOEs will still dominate. Government support for initiatives such as BRI and AIIB will not only fuel infrastructure-related sectors, but also boost bilateral trade over the medium term, with upgraded interconnectivity. These initiatives may also promote increased RMB usage in funding for infrastructure projects and trade deals.

This article was first published in the magazine The Bulletin April 2018 issue. Please click to read the full article.

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