Whilst much attention has been focused on United States/China business risk and relations following the election of President Trump in the United States, other unrelated but more pressing threats to foreign business have arisen in the PRC.
Beijing’s ongoing and apparently escalating measures to contain capital outflows are already having a significant impact on foreign business operating in mainland China. Boards of directors and senior management need to take note immediately.
The crackdown has, from the mainland government’s perspective been successful and has, for now, staunched fund outflows with the result that China’s foreign exchange reserves rose by USD6.92 billion in February 2017, back above levels of USD3 trillion.
Tightening of Capital Controls
China’s government has temporarily resolved its “trilemma” of choosing between a loose monetary policy, a liberalising capital account and a controlled exchange rate – by tightening capital controls. The government quietly shifted policy after a mid-2015 stock market collapse, a sudden 2% devaluation in the yuan, and subsequent capital flight, all of which stoked fears about economic stability.
This policy has taken shape over the last eighteen months. Amongst other shifts, the State Administration of Foreign Exchange (“SAFE”)’s approval of foreign exchange applications slowed in early 2016, and in November 2016 the People’s Bank of China (“PBOC”) limited overseas investments by state owned enterprises. China’s outbound investment in the first quarter of 2017 fell 74% on a year earlier.
At a lower level, the SAFE in September 2015 curtailed overseas cash withdrawals through China UnionPay, a payment system, and in October 2016 closed a loophole on investment-related insurance policies. Public security officials in China have shut down many underground banks, and in Macau police have curtailed the use of cross-border sales terminals.
The Threat to Foreign Business
For all its success in slowing capital outflows, though, Beijing’s policy poses threats to foreign businesses. One immediate problem is weakened demand from Chinese customers, affecting industries across Asia. The end of the China UnionPay exemption damaged Hong Kong’s insurance business (selling into the mainland), and a decline in Chinese money has softened property prices in Johore, Sydney and Vancouver.
Payment risk is now a serious threat. Chinese companies are struggling to transfer funds, meaning investors expecting dividends from shares or repayments on bonds could see delays in settlement, or even default. Companies dealing with Chinese manufacturers or exporters may also face payment difficulties.
Perhaps the most worrying threat however relates to enforcement. As ever after a policy shift in China, the number of investigations has risen, and it is just a question of time before the authorities decided to “kill a chicken to scare the monkeys”. A concern is that foreign businesses or executives will come under investigation. Trading companies are at particular risk, for instance, as the mispricing of goods is a common means to move funds out of China and this is well understood by the central government.
Sitting this policy shift out will not work – the threat is unlikely to diminish. Rather, capital controls also provide a tool with which China’s officials might respond to any US tariff rises, and regulatory action on capital flight may well become institutionalised, as has the anti-corruption campaign. Indeed, in February 2017 SAFE launched inquiries on trading businesses’ exposure to tariff rises, highlighting its role as an arbiter of policy on aspects of both trade and capital flows.
What to do?
Foreign businesses must respond to this changed environment. Regulatory action against almost any link in a payment chain will present a threat to operations, and may also result in the arrest of foreign or local executives. Companies should thus conduct an appraisal of payment systems to and from China, so as to gain full understanding of any risk and to plan mitigation measures.
Businesses reliant on fund flows from China should also reassess their financial positions to take account of prospective delays in payment, or even of defaults. In particular, companies should conduct intensive research on investment products linked to China, such as offshore “bonds” issued by Chinese companies, so as to ensure that they do not rely on transfers through questionable structures.