SVA Assessment – China’s Riskier Business Environment – What foreign companies need to do to survive

For two decades, China’s investment environment has proven stable. Constant economic growth, steady reform and political stability meant investors could hitherto plan with some certainty. This situation was remarkable; few investors would have predicted in 1989 that China would offer stability for so long.

That era is now over. The coming to power of Xi Jinping in November 2012 has transformed the political environment. Moreover, the severity of the economic downturn has presented new risks. Investors must act to safeguard their interests.

A Change in Management

In November 2012, Xi Jinping became General Secretary of the Chinese Communist Party (“CPP”), taking over from Hu Jintao. Shortly thereafter Xi launched an anti-corruption campaign unprecedented in scope, targeting corrupt officials and political opponents, many linked to Hu Jintao and his predecessor Jiang Zemin.

This campaign has fundamentally changed the political climate. To some extent, political stability in recent years related to the dominance of Jiang Zemin, who retained sway long after stepping down in 2002. The anti-corruption campaign has cut back Jiang’s influence, though, by removing allies such as Zhou Yongkang, a former Politburo Standing Committee member, as well as lowlier acolytes.

This political shift has had radical consequences. Many thousands of officials have come under arrest, or lost their posts. Changes in leadership have occurred at government agencies and State Owned Enterprises (“SOEs”), resulting in policy shifts, investigations and a bureaucratic freeze. In short, Xi has instilled fear; the rules of engagement have changed – and on a backdated basis.

Economic Malaise

A wrenching economic shift has also started. Officially, GDP expansion has slipped to 6.9%, as a transition from an investment-led system to one reliant on consumer spending takes effect. Even that faces challenges; China’s high savings rate, the tax system, and the hukou household registration system, all raise doubts about whether such a shift is tenable. In the interim, the government faces challenges. The world economy cannot absorb the overcapacity in Chinese industry, and the level of debt in the financial system has soared dangerously high. The scope for error is high.

The Threat to Business

For business, these political and economic shifts have manifested themselves in tougher regulation. Since 2012 signs have emerged of a rising tide of economic nationalism, with anti-monopoly actions focused on sectors in which foreign providers have strong market share, such as technology, pharmaceuticals, milk powder and luxury cars. Foreign companies have also come under investigation for corruption.

Crisis measures present other risks. In the securities sector, efforts to stem a share price collapse have led to de facto prohibitions on the unloading of equities and short selling, as well as to the arrest of senior regulators and financiers. Worse, a sense is rising that certain “normal” market activity can now be unpatriotic – hence recent criticism of tycoon Li Ka-shing’s sale of Chinese assets in the state media.

A longer term risk is that the reform agenda has stalled. Take the SOEs; measures outlined in November 2013, of the creation of holding groups, of professional management, and of part-privatisation, seem to have petered out. Without reform, though, the economy will struggle to acquire a more sustainable footing.

What to Do?

This loss of certainty is real. Investors must jettison expectations shaped by a former age, and act to protect their interests, including by:

  • Commissioning research exercises to better understand post hoc exposure, with a focus on the identification of any “ticking political bombs”.
  • Carrying out independent due diligence investigations into business partners and key counterparties, so as to understand their political affinities and the risk of prospective investigations.
  • Conducting forward-looking assessments of risks deriving from shifts in government policy and regulatory actions.
  • Implementing influence mapping exercises to identify prospective partners who might be able to provide protection in the new climate.
  • Identifying “winners and losers” in the rapidly shifting landscape and planning accordingly.

SVA is in a strong position to help in this regard. Please do not hesitate to contact us as to our Business Intelligence Services at the numbers below or via email to [email protected]