Navigating a Tougher China Market – A Brief for Senior Management

The 19th Chinese Communist Party (“CCP”) Congress on 18 October will probably tighten the political, regulatory and strategic environments in mainland China. Such changes present risks to businesses both inside and outside the country – but not insuperable challenges, if investors can adapt to the new climate.

The New Politburo Line Up

The Congress will choose a new Central Committee, which will select the Politburo and its Standing Committee (“PBSC”), the highest bodies in China. These staffing decisions will dictate China’s political power and direction in the years ahead.

When CCP General Secretary Xi Jinping took office in 2012, he accepted opponents sitting on the PBSC; now, he seemingly wants to replace these “mothers-in-law” with his own appointees, and perhaps to retain office beyond 2022.

Xi has considerably bolstered his clout through the highly publicised anti-corruption campaign, and also by reinvigorating the party. In 2015, the authorities announced new rules for CCP cells, which have expanded in the public, private and foreign firm sectors; in early 2015, 52% of bigger private firms had such cells, but by July 2017 over 70% of China’s private businesses did.

The Congress will formalise these changes. Ties to certain officials could become liabilities, as anti-corruption efforts expand; and party cells may demand reorientation of investments or access to intellectual property, if corporate and party interests conflict. In short, the political strictures on business inside China will increase.

The Regulatory Thicket

Conversely, the Congress has required economic stability, owing in part to fears stoked by the August 2015 stock market fall and capital outflows. Beijing has since slowed debt accrual, purged regulators, and strengthened capital controls.

Foreign exchange reserves, which from 2015 to 2017 fell from USD3.5 trillion to USD3 trillion, have stabilised; but overseas investment has also tumbled, to USD57 billion in the first seven months of 2017, down from USD103 billion over the same period in 2016.

These regulatory measures and payment risks could thus ease after the Congress, as the political outlook becomes clearer and the need for stability wanes.

Strategic Qualms

The Congress may also shape external perceptions. China’s government has touted an investment strategy built around the One Belt, One Road (“OBOR”) initiative, and the purchase of high-technology businesses, which the Congress will formalise.

This approach is worrying some foreign governments. The US Committee on Foreign Investment is poring over Chinese purchases more closely, and Australia has taken a cautious approach after the sale of Darwin’s port irked Washington.

European states have also become edgy. In 2016 the sale of a robotics firm prompted debate in Germany, and in June 2017 French President Macron demanded protection for European companies. As such, businesses must plan around this chariness; dealing in China could pose political risks elsewhere unless carefully considered in advance.

Leveraging off the Belt and Road

Of course, opportunities still abound. China’s transition towards consumption-led growth continues, regulation has reduced risks, and capital outflows have not vanished – rather, a readjustment is under way.

The State Council, China’s cabinet, now classifies investment as “encouraged”, “restricted” or “prohibited”. OBOR investments are “encouraged”, and rose to USD33 billion in the first seven months of 2017, up from USD31 billion for all 2016. State banks are seeking capital outside China, offering quasi-government guarantees on OBOR projects. The Congress should endorse this shift.

How Should Businesses Respond?

This new climate, which the Congress will enshrine, poses challenges to businesses – but not insuperable ones. Firms can benefit if they respond in the following ways:

  • Companies invested in China should carry out a real world audit of vulnerabilities, such as business partners’ liability to anti-corruption actions.
  • Companies in China should examine the structure of payment systems, so as to understand the risk of falling foul of capital controls.
  • Businesses reliant on fund flows from China should assess the impact of payment delays, or even of default, on projects outside the country.
  • Financial businesses should conduct research on investment products, so as to ensure that any structure is not exposed to capital controls, and so sub-par.
  • Business operating within the “restricted” investment category should consider restructuring investments, so as to meet OBOR criteria.
  • Companies outside China should consider perceptions of Beijing’s investment strategy elsewhere, alongside the risks of doing business in China.

SVA has specific experience of evaluating risk to foreign firms under such changing circumstances and we stand ready to be of assistance to companies in mitigating risk.