China issues guidelines on overseas investment of state-owned enterprises

BEIJING (REUTERS, BLOOMBERG) - China's finance ministry has issued guidelines on overseas investment of state-owned enterprises (SOEs), amid a campaign to tighten controls on outbound investment and financial risks.

China's giant SOEs making products from trains to chemicals have been leading the country's "go out" drive with growing overseas investments, but they have encountered low returns on investment and weak profitability, the ministry said.

The guidelines will help "strengthen financial management of overseas investment of state-owned enterprises, prevent financial risks and improve investment efficiency", the ministry said in a statement on Wednesday (Aug 2).

China is increasingly scrutinising overseas spending by both private and state-owned firms, amid growing concerns about rising debt levels and potential systemic financial risk.

The guidelines, which come into effect from August (2017), covered the areas of investment decisions, financial management, cost control, dividend distribution and foreign exchange business.

"Greater outbound investment by SOEs is going to take place and many of them lack the ability to properly manage risks," director Xu Baoli of the research centre at China's state-owned assets regulator told the official China Daily newspaper.

"The lack of accountability of senior executives for poor or failed investment is one of the reasons that lead to radical decision-making and loss-making deals."

President Xi Jinping's top economic adviser commissioned a study earlier this year to see how China could avoid the fate of Japan's epic bust in the 1990s and decades of stagnation that followed.

The report covered a wide range of topics, from the Plaza Accord on currency to a real-estate bubble to demographics that made Japan the oldest population in Asia, according to a person familiar with the matter who has seen the report.

While details are scarce, the person revealed one key recommendation that policy makers have since implemented: The need to curtail a global buying spree by some of the nation's biggest private companies.

Communist Party leaders discussed Japan's experience in a Politburo meeting on April 26, according to the person, who asked not to be identified as the discussions are private.

State media came alive afterwards, with reports trumpeting Mr Xi's warning that financial stability is crucial in economic growth.

Then in June came a bombshell: reports that the banking regulator had asked lenders to provide information on overseas loans made to Dalian Wanda Group, Anbang Insurance Group, HNA Group, Fosun International and the owner of Italian soccer team AC Milan.

While the timing of those requests is unclear, other watchdogs soon issued directives to curb excessive borrowing, speculation on equities and high yields in wealth-management products.

Mr Jim O'Neill, previously chief economist at Goldman Sachs Group and a former UK government minister, said Chinese policy makers are constantly looking to avoid the mistakes of other countries - and Japan in particular.

"You see it in repeated attempts to stop various potential property bubbles so China doesn't end up with a Japan-style property collapse," Mr O'Neill said in an e-mail. "There does appear to be some signs that some Chinese investors don't invest in clear understandable ways, but they wouldn't be the only ones where that is true!"

On Tuesday (Aug 1), Vice-Commerce Minister Qian Keming told reporters that Chinese companies must be prudent in outbound investment in the entertainment, sports, hotel and property sectors.

The moves reflect concerns that China's top dealmakers have borrowed too much from state banks, threatening the financial system and ultimately the party's legitimacy to rule - a key worry ahead of a once-in-five-year conclave later this year that will cement Mr Xi's power through 2022.

The study was commissioned by Mr Liu He, whose role as director of the office of the Communist Party's top economic policy committee makes him one of Mr Xi's most-senior advisers, the person said.

It provides at least one key reason for China's moves to rein in outbound investment that jumped to a record US$246 billion (S$335 billion) last year. The impact has been swift: Acquisitions abroad tumbled 55 per cent in the first six months from the same period in 2016, according to data compiled by Bloomberg.

Beyond stemming China's deal flow, the study also recommended: A new national law to spell out the rules for overseas investments. Companies currently need approvals from the commerce ministry, the top foreign-exchange regulator and the national economic planning body Tighter scrutiny by regulators on the long-term viability of overseas investments - particularly return on assets - to ensure that risks do not blow up.

It likened Chinese companies to speculative retail investors looking for quick returns on the stock exchange.

The study warned that China was in danger of emulating Japan in the 1980s, when it had become a manufacturing powerhouse after years of near double-digit economic growth.

It cited Japanese purchases of everything from Pebble Beach golf club to Columbia Pictures to Rockefeller Centre in New York as examples of what could go wrong when companies have a strong currency and the ability to borrow cheaply against surging land valuations at home.

China is now moving to ensure its companies do not repeat those mistakes.

Still, even as authorities look to deleverage the economy, the Communist Party remains committed to ensuring annual growth of about 6.5 per cent this year to achieve a promise of building a "moderately prosperous society" by 2020, with gross domestic product and income levels double those of 2010.

Whether they can both hit that target and curb financial risks is an open question.

"The deleveraging push is serious when it comes to limiting the potential for systemic financial stress in the short-term," said Mr Logan Wright, Hong Kong-based director of China markets research at Rhodium Group. "But it is less clear that Chinese authorities are truly prepared for the longer-term economic consequences of a financial system growing at a much slower rate in the future."