Security concerns are weakening China’s place in the world

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Hello from Italy, where I am in quarantine for five days before visiting family. Rome is trying to keep in check the Delta variant of coronavirus that is threatening the economic recovery of many countries around Europe.

We’re not the only ones suffering from a lack of freedom as a result of the pandemic. Today’s main story looks at how Chinese outward investment has rapidly weakened, limited by increased scrutiny both at home and investment destinations. The trend is in stark contrast with expectations of a spending spree, with Chinese groups feasting on distressed companies in advanced economies. It bucks the strong rebound in global mergers and acquisitions too.

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The foreign, and homegrown, fears behind FDI’s fall

China’s role in global investment has diminished dramatically.

Its greenfield foreign projects in the 12 months to May almost halved compared with the previous 12 months.

This is much worse than the almost 30 per cent drop across the globe over the same time, with falls of about 25 per cent for the UK, the US and Europe’s leading economies.

The scale of the decline means Chinese companies dropped from being the sixth-biggest investors in greenfield projects to ninth place in the most recent 12 months, overtaken by Switzerland, the Netherlands and Spain.

Outbound Chinese mergers and acquisitions fell too. In the year to date, the number plunged 37 per cent compared with the same period in 2019, while the value of the deals stagnated.

Column chart of year to date, deal value ($bn) showing Chinese companies lag behind in the foreign M&A rebound

This is against a backdrop in which M&A activity has surprised many by picking up, pushing the value of deals to a multiyear high.

China was the only major global economy to expand last year. So what exactly is going on?

One part of the story is foreign governments’ security concerns.

The UK government, for instance, recently intervened on the acquisition of the country’s UK’s largest silicon wafer manufacturer. Canada and Australia blocked the takeover of two construction companies. And Italy and Germany vetoed a Chinese acquisition of a national semiconductor company and a satellite group respectively.

Tougher investment screening frameworks are already having an impact — including the UK National Security and Investment Act, which is set to officially become law later this year. “The UK Government is reserving the ability to call in for review, once the rules are operational, any deals that have completed since November 2020, when the bill was published by the UK government,” said Sunny Mann, partner at Baker McKenzie. “This has prompted a number of acquirers to already start filing their proposed investments voluntarily with the newly formed investment screening unit.”

The UK’s step follows similar laws in the EU and Australia. Earlier in the year, US president Joe Biden signed an executive order to prohibit investments in 59 Chinese companies on security grounds, including Huawei, the telecoms equipment manufacturer, and Semiconductor Manufacturing International Corporation, China’s largest chipmaker.

The trend is well recorded by the recent annual report by Unctad, which tracks global investment and counted 50 restrictive measures in 2020, against 21 in the previous year, largely “driven by national security concerns over FDI in sensitive industries”. Many were introduced by developed economies.

Column chart showing the number of global restrictive investment measures have jumped in 2020

But this is far from the only cause. There are factors closer to home too.

Thilo Hanemann, partner at Rhodium Group, a think-tank, said that while greater regulatory and political scrutiny abroad was a factor, “the fall of Chinese outbound investment since 2017 is largely a Chinese story”.

“Beijing reimposed capital controls as outflows grew too large for its comfort,” he said. The crackdown on large private conglomerates, such as Alibaba, tighter liquidity in the market, and concerns about access to sensitive personal data have become additional drivers in the past two years.

The US-China Investment Project, a think-tank, noted in a recent report that “throughout the pandemic, Beijing prioritized stability, refusing to loosen restrictions on outbound investment by private companies despite a massive trade surplus and upward pressure on its currency”.

“In China, the balance that leaders strike between domestic financial stability and openness to the outside world will shape the investment landscape,” the report said.

Deals so far this year are down more than four-fifths on the level seen in 2016. Hanemann said that a return to those high levels was “unlikely in the near future”.

Max J Zenglein, chief economist at Mercator Institute for China Studies, a think-tank, agreed that a pick-up was unlikely in the coming months. While the general interest in gaining access to foreign technology and securing market access had not changed, “the changing political circumstances require some adjustments”. As a result, he expected the structure of Chinese FDI would change, for example with more venture capital investments.

China could also see “more onshoring of critical technology and R&D” as “absorbing global value chains into China can be seen as a direct response to increased economic defence measures complicating Chinese investments abroad”, said Zenglein.

The trend towards shifting investment back home has been catalysed by the pandemic. In China, at least, we’re increasingly sure it will outlive it.

Trade links

Brussels has, somewhat unsurprisingly, said it will not renegotiate the Brexit deal. That refusal came after the UK’s Brexit minister Lord David Frost issued a paper calling for the so-called Northern Ireland protocol agreed with the EU in 2019 to be renegotiated. Philip Stephens thinks the Johnson government has acted in bad faith, taking a stance it knows the EU cannot accept.

Tesla has agreed to buy nickel for its batteries from BHP, the world’s largest miner, as it looks to lock up supplies of the metal not controlled by China.

Reuters reports that the meat industry is warning that UK supply chains are now at risk of failing due to pandemic-related labour shortages.

As Beijing and Moscow bolster diplomatic ties, the city of Blagoveshchensk on the Chinese-Russian border is pursuing a trade and tourism boost (Nikkei, $, subscription required). Taiwan Semiconductor Manufacturing Company, the world’s biggest made-to-order chipmaker, may put its first chip plant in Japan into operation as early as 2023 (Nikkei, $). The aim is for it to supply electronics group Sony.

The Peterson Institute for International Economics has an interesting critique of the International Trade Commission’s assessment of some of the agreements negotiated under the now expired Trade Promotion Authority. The assessment claims the US economy is 0.5 per cent bigger as a result of the deals. Claire Jones

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