China Waffles on Investment Curbs

An analysis by Michael Lelyveld
china-pboc-pedestrians-sept28-2016.jpg Pedestrians walk past the headquarters and head office of the People's Bank of China, China's central bank, in Beijing, Sept. 28, 2016.

China has had mixed success in protecting its stockpile of foreign currency reserves by restricting investment overseas and keeping capital from flowing abroad.

On Friday, the People's Bank of China (PBOC) reported a slim gain for foreign exchange reserves of U.S. $3.96 billion in March, but it was enough to mark the second month of growth in a row. Reserves rose to U.S. $3.0091 trillion from U.S. $3.0051 trillion at the end of February, the PBOC said.

Slight movements have been closely watched since January when reserves fell below the U.S. $3-trillion level for the first time since 2011.

Officials have denied that the threshold has anything more than psychological significance, yet the regulators have tried to impose major restrictions on outbound investment to stay above it while defending the value of the yuan.

Pressure has eased slightly on both the currency and the reserves in the past month, thanks in part to regulatory steps against capital outflows and investments abroad.

In March, the government mapped plans to tighten restrictions on outbound direct investment (ODI) following signs that some deals were defying the country's capital controls.

State media reported that government agencies were drafting a regulation that would formally bar investments in foreign real estate and other sectors that officials have tried to discourage since last year.

The rules being considered by the Ministry of Commerce (MOC) and the National Development and Reform Commission (NDRC) would "clarify and define the range of overseas investments, as well as listing prohibited areas and other essential factors," the state-controlled Economic Information Daily said.

The report citing an unidentified "insider" followed an interagency warning in November that the government would "tighten screening of overseas investment projects amid growing concern about capital outflows and acquisition risks."

Rising concerns

Concerns have been rising since China became a net capital exporter in 2015 after years of inflowing investment from abroad. The reversal added to pressures on the country's currency and foreign exchange reserves.

Last year, ODI soared 44.1 percent to U.S. $170.1 billion (1.1 trillion yuan), while foreign direct investment (FDI) in China rose by a much milder 4.1 percent to 813.2 billion yuan (U.S. $118.2 billion), according to MOC data.

The imbalance was partly the result of perceptions that the stronger dollar and rising interest rates in the United States offer greater opportunities for returns than the weakening yuan.

Regulators worried that the trend was becoming a self-fulfilling prophecy as capital streamed out of China into real estate and a wide range of investments overseas.

Last year, China's banks were reportedly told to slow down currency conversions as part of a tougher review process aimed at raising barriers to a flood of outflows, merger and acquisition deals and foreign property sales.

In December, the MOC and NDRC issued a joint statement with the People's Bank of China (PBOC) and the State Administration of Foreign Exchange (SAFE), warning that they were "closely monitoring the tendency of 'irrational' overseas investment in some areas."

The statement singled out investments in real estate, hotels, cinemas, entertainment and sports, the state's Xinhua news agency said.

The official English-language China Daily said the guidelines were intended to "control risks and rein in illegal capital outflow," suggesting that investments in the flagged sectors were currency speculation and capital flight in disguise.

"Chinese companies' outbound investments might have raised their global profile, but have done little to alleviate fears of capital flight," Xinhua said on March 26.

The new rules do not affect strategic investments like ChemChina's proposed U.S. $43-billion (296 billion yuan) takeover of the Swiss-based agricultural technology giant Syngenta, which was cleared by both U.S. and European Union regulators last week.

Experts say China's outbound investments have slowed markedly following the government warnings, although foreign investment in China has also weakened.

In the first two months of 2017, non-financial ODI plunged 52.8 percent from a year earlier to U.S. $13.4 billion (92.2 billion yuan), while FDI in China fell 2.3 percent to 139 billion yuan (U.S. $20.2 billion).

"We are seeing a clearly lower value of total (ODI) deals since November," said Derek Scissors, resident scholar at the American Enterprise Institute in Washington, which compiles the China Global Investment Tracker with the Heritage Foundation.

"There is still a daily onslaught of investment stories, but not nearly as many agreements in the $1-billion-plus range," Scissors said.

A view of the headquarters of Anbang Insurance Group in Beijing, China, March 13, 2017.
A view of the headquarters of Anbang Insurance Group in Beijing, China, March 13, 2017.
Credit: ImagineChina
No longer off-limits

Yet, some overseas investments are still taking place in sectors that are supposed to be off-limits, raising questions about the effectiveness and enforcement of the government controls.

On March 24, for example, SeaWorld Entertainment Inc. announced that the Beijing-based Zhonghong Group would acquire a 21-percent interest in the U.S. theme park operator for some U.S. $429 million (2.9 billion yuan).

Under the deal with the New York-based Blackstone Group, the Chinese company agreed to pay a 33-percent premium over SeaWorld's previous share price, Reuters reported.

Zhonghong is described as a diversified holding company for investments in real estate, leisure and tourism. But there has been no explanation of how the deal squares with the government's warnings against ODI in the entertainment field.

Similarly on March 20, Bloomberg News reported that the Chinese conglomerate HNA Group is leading a U.S. $2.21-billion (15.2-billion yuan) deal to acquire a New York office tower at 245 Park Avenue, said to be one of the highest prices paid for a property in the city.

The building is close by the luxury Waldorf Astoria hotel, which China's Anbang Insurance Group bought for U.S. $1.95 billion (13.4 billion yuan) in 2015. But again, there was explanation of how such investments abide by the government's announced policy on foreign real estate deals.

It is unclear whether some major investors have been disregarding or defying the government guidelines, or whether perhaps their government connections have made them immune.

Scissors suggested that enforcement of the restrictions may depend on the source of financing for the investments.

"It's when you come to the state financial system for money that the restrictions apply," he said.

So far, the government agencies have not spelled out the terms or limits of their policy on outbound investment, which may be a reason to codify it in a regulation.

Scissors said the rule is also "an attempt to convince Chinese investors this is not a temporary situation they can just wait out."

Two minds

But the government has also seemed to be of two minds about curbs on overseas investment, at one point appearing almost apologetic for the rules.

At a Dec. 23 press conference in Beijing, MOC spokesman Shen Danyang said that "the authorities encourage companies to continue to expand and operate internationally," despite the limits on "irrational" ODI, according to a China Daily report.

Whatever the reasoning or the rigidity of the restrictions, the government's attempt to ban entire categories of outbound investment stands in sharp contrast to the image that China has projected internationally as an engine of world economic growth.

It also flies in the face of commitments that China reportedly made to the International Monetary Fund on opening its capital account as a condition for including the yuan in the IMF's Special Drawing Rights (SDR) basket of freely-traded currencies in 2016.

The decision to accept the yuan for the SDR basket was hailed as a major step forward for China, but the restrictions on investment will be seen as a step back.

Scissors said the new rules will make little difference to the SDR issue, since both the commitments and the inclusion were "a farce."

In a statement reported by Xinhua on March 27, the PBOC appeared to be troubled by the contradiction between its IMF commitments and the restrictions on investment.

"China will steadily liberalize the yuan's use on the capital account, which makes the currency convertible for investment purposes, as part of the country's strategy to make the yuan a global currency," PBOC Deputy Governor Yo Gang was quoted as saying.

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