As China’s economy matures, its companies are looking for opportunities to expand around the world.
Chinese outbound direct investment (ODI) has increased dramatically since the PRC government introduced the “go abroad” policy earlier this decade. Though China’s high savings rate and stock of foreign exchange reserves suggest that the country has the potential for substantial investment outflows, ODI was initially slow to develop, rising into the $10-$20 billion range only after 2004. Thanks to the recent acceleration, however, outbound flows have risen at a compound average growth rate of roughly 60 percent from 2000 to 2007, and expanded at a similar rate in 2008, according to the PRC Ministry of Commerce (MOFCOM). Although Chinese ODI dropped early this year, outflows picked up in the second quarter; total ODI for 2009 may not be much different from last year’s $52.2 billion. Mainland China now ranks third among developing countries (after Brazil and Russia) for ODI flows and fifth overall (after Russia, the British Virgin Islands, Singapore, and Taiwan) in terms of ODI stock. More relaxed rules and PRC government support for enterprises that want to enter overseas markets have made China one of the most active investors of the emerging world. Still, China’s investment remains dwarfed by global ODI, to which China contributes only about 1 percent, according to the Organization for Economic Cooperation and Development.
In 2007, the most recent year for which detailed Chinese ODI figures are available, China’s ODI stock totaled nearly $118 billion while ODI flows exceeded $26 billion, according to MOFCOM. This is a massive increase compared with historic levels. For example, from 1982 to 1989, annual ODI flows were less than $500 million, and between 1990 and 1999, this amount rose to just above $2 billion. But in 2005, the year of the first big surge, ODI flows jumped to $12.3 billion, and they continued to surge up to the outbreak of the global crisis at the end of 2008. A decade ago, outflows were dwarfed by annual foreign direct investment (FDI) inflows of $30-$50 billion. In recent years, outflows have risen from about 5 percent of inbound FDI to equal roughly one-third of inflows.
Where is Chinese investment going?
China’s investments are spread unevenly around the world, with Asia, and especially Hong Kong, receiving the largest share. But much of the investment that goes to Hong Kong is “round-tripping,” a strategy by which a mainland Chinese investor sends funds through a foreign company that are then reinvested back into China as foreign capital, enabling the investor to take advantage of special tax incentives for foreign investment. Tax havens such as the Cayman Islands and British Virgin Islands also disguise where Chinese investments actually go. Though these features of China’s flows may inflate its total ODI numbers and distort regional comparisons of flows, the ODI figures for Europe and the United States are considered a fairer reflection of the actual flows because much of the measurement problem pertains to ODI flows with Hong Kong and other parts of Asia. Even excluding ODI flows into Hong Kong and other tax havens, however, Chinese investment is still mainly concentrated in Asia. Investment in North America and Europe remain extremely low as a share of total Chinese ODI, especially considering that these are China’s main export destinations.
The hunt for resources
Some observers suggest that the geographical distribution of Chinese ODI has been the result of China’s historic preference for investing in regions that offer access to natural resources, satisfying a strategic need for resource security. Chinese companies that invest in resource extraction abroad often target other developing countries, especially in Africa and Asia. At times, large state-owned enterprises have also targeted developed economies, such as the United States and Australia, through resource-related investments. For example, in 2005, China National Offshore Oil Corp. bid against Chevron Corp. to acquire Unocal Corp., and Aluminum Corp. of China Ltd. recently sought to buy a stake in Rio Tinto Ltd. Both of these deals failed, however, because of political and shareholder pressure in the recipient countries.
A shift to services
According to the resources theory, much of China’s ODI to date has been aimed at sourcing inputs for Chinese industry rather than developing sales or establishing businesses embedded in end-consumer countries. This view to some extent helps explain the low levels of interest in the European Union and United States. But this pattern may be changing, as some Chinese investments overseas have recently shown signs of moving into sectors other than resource extraction (see China’s Investment in Europe: A Shift to Services). Since 2004, services have become the dominant sector for Chinese investments abroad, and in 2006, China began investing heavily in the financial sector, which was the third most important destination for Chinese ODI flow that year and the sixth most important destination in 2007. But to some extent, such developments reflect less movement away from resources than rapid growth in China’s overall ODI. Companies appear to be placing much greater emphasis on commercial incentives and business growth, leading to a shift in recipient countries and regions.
China’s Outbound Investment Rules
The PRC government has sought to encourage and regulate the rapid growth of China’s outbound direct investment (ODI) in recent years by advancing a long-term “go abroad” policy. In July 2004, the PRC Ministry of Commerce (MOFCOM) published China’s first Guiding Catalogue of Countries and Industries for Overseas Investment, which listed 67 industries— mostly types of manufacturing—in which Chinese companies would receive preferential treatment when they invested abroad. Revised catalogues released in 2005 and 2007 expanded incentives for resource extraction and investment in Asia and North Africa. In April 2009, MOFCOM introduced a new online resource for Chinese companies investing abroad. The investment guide, which will be updated regularly and includes information on more than 160 countries, provides advice on setting up enterprises overseas, advice on potential problems that Chinese companies may encounter abroad, and answers to frequently asked questions. Central-level PRC agencies have also revised several measures related to Chinese ODI, bringing significant change to outbound investment procedures.
MOFCOM revises the investment approval process
MOFCOM’s Measures for the Administration of Outbound Investment, which took effect May 1, 2009, give the agency greater control over high-level and sensitive ODI. MOFCOM must approve outbound investments of $100 million or more; provincial-level commerce departments will approve most investments between $10 million and $100 million. (Previously, all central-level enterprises had to file investment applications with MOFCOM, while local-level enterprises could obtain provincial approval.) In addition, all investments involving multiple countries, certain yet-to-be-determined countries or regions, and countries that do not have diplomatic relations with China require MOFCOM review. MOFCOM retains jurisdiction over investments that involve incorporation of offshore special purpose vehicles. The rules also establish a more localized and efficient application process for low-value ODI.
NDRC adopts new rules for overseas acquisitions
New National Development and Reform Commission (NDRC) rules require Chinese enterprises to submit a preliminary report on intended mergers and acquisitions overseas before any legally binding contracts are signed. The report must provide details on the investor, investment project, and intended timeline. The preliminary review process is in addition to the requirements of the 2004 Administrative Measures on Approval of Investment in Overseas Projects, under which enterprises must secure NDRC approval for outbound investments that exceed $10 million.
SAFE relaxes forex restrictions
Qualified domestic enterprises may provide loans to their overseas subsidiaries, according to State Administration of Foreign Exchange (SAFE) rules that took effect August 1. Under the new measures, companies operating in China that meet certain requirements, such as maintaining sound business records and complying with foreign-exchange rules during the past three years, can provide loans to a wholly or partially owned offshore subsidiary. The loan can be issued in the form of local or foreign currency, cannot exceed 30 percent of the domestic company’s equity share, and must be approved by the local SAFE branch. The PRC government previously allowed only multinational corporations to lend to their offshore subsidiaries, but it has expanded the rules to make it easier for Chinese companies to finance overseas investments.
SAFE has also eased restrictions that allow small and medium-sized domestic enterprises to expand overseas. According to the Administrative Regulations on Direct Outbound Investment by Domestic Entities, which also took effect August 1, Chinese companies only have to declare the source of their funds and register their remittance with SAFE rather than apply for prior approval. In addition, companies can now use their own foreign exchange or borrow foreign exchange from Chinese banks to fund overseas investments.