China’s new rules on overseas mergers and acquisitions, released on August 18, lay out three categories of investment: banned, restricted, and encouraged. These guidelines will have a lasting effect on direct investment abroad. How will it affect overseas investment in the real estate sector and China’s own economic health?
New regulations on outbound investment
The rules issued by the State Council and the National Development and Reform Commission categorize overseas investments according to their alignment with state policy initiatives. Banned industries include those in the military, gambling and sex industries. Restricted industries include those in real estate and hotels, film and entertainment, sports, and those that do not comply with environmental standards. Encouraged industries include those that promote the Belt and Road, improve China’s technology or research and development, and those that expand oil, mining, agriculture and fishing.
The purpose of the new regulations is to reduce irrational outbound investment and to improve the development of China’s overseas investment. China has been attempting to crack down on capital flight resulting from a slowing economy and downward pressures on the exchange rate. The latest rules impose yet another layer of controls on outbound capital. As a result, firms will have less command over how to invest their funds.
Impact on the real estate sector
Much of the overseas investment has taken place in the real estate sector. The purchase of Strategic Hotels and Resorts by Anbang Insurance for $6 billion and of Starwood Capital Group by China Life Insurance for $2 billion in 2016 became symbols of Chinese overseas buying prowess. The Chinese presence in American real estate in particular became quite noticeable, as Chinese investors became the largest group of foreign investors in U.S. commercial real estate last year.
Now, all of this has changed. According to the Ministry of Commerce, overseas direct investment in the property sector declined by 82% in the first half of 2017, and it looks set to decline even further as the new measures specifically restrict firms’ acquisitions of real estate in foreign markets. According to a research note by CBRE, state-owned enterprises in particular reduced their activity in overseas real estate.
The new regulations are likely to stall foreign property acquisitions, at least in the short term. Dr. Henry Chin, Head of Research in the Asia-Pacific, and Sam Xie, Head of Research in China, of CBRE, write that “outbound investment will continue but the pace of capital deployment is likely to slow as investors adjust to the new rules and fine tune their investment strategies. [However,] CBRE Research expects to see robust investment by SWFs and a renewed focus on investment related to the Belt & Road initiative.” Chin and Xie believe that Chinese investors will find ways to get around the new controls, becoming more likely to purchase foreign real estate by using offshore financial institutions, investing through Hong Kong, and selling their operational expertise overseas.
Effect on China’s economic health
The new restrictions dampen market forces, which Western experts often view as a negative, but may to some extent have a positive impact on China’s economic health. The reason for this is because many of China’s overseas acquisitions have been funded by debt, which is already sky-high among Chinese firms. At the end of 2016, corporate debt was 166% of GDP, according to BIS data. The IMF warned in its annual review of China this month that, “the growth outlook…comes at the cost of further large and continuous increases in private and public debt, and thus increasing downside risks in the medium term.”
Economic health may also be boosted by the sector-related restrictions. This is because preventing overseas investment in the gambling and sex industries, and restricting investment in the real estate and entertainment industries, will reduce overseas holdings in sectors that are not central to China’s government directives and its long-term objectives. The may help Chinese industries to become more efficient, as China’s leadership looks to rationalize its economy.
To sum up, the new capital controls may put a damper on overseas real estate investment, at least until firms find loopholes to work around this restriction. The controls may also reduce the role of market forces, but they are likely to reduce corporate indebtedness, which has become a huge problem in the Chinese economy, and help industries to work toward the government’s long-term objectives. The impact is mixed, but the rules are here to stay.
Courtesy of Forbes and credited SaraHsu
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