How Chinese firms navigate the new global trade landscape

With the rise of protectionism and deglobalization around the world, Chinese companies are prudently revisiting their investment strategies.

The geopolitical landscape is changing and posing unique challenges for Chinese firms seeking to invest overseas. Cross-border investment regulations are becoming increasingly stringent; deglobalization is influencing global value chains; and a general trend toward protectionism has been spreading across the developed world.

Chinese firms are factoring the geopolitical environment as they plan their investments abroad which their considerations are evident in the recent decrease in completed M&A deals and the reduced volume in China’s outward direct investment (ODI). 

Geopolitical challenges

From its peak in 2016, the downward trend of China’s ODI can be linked directly to a more restrictive overseas investment landscape, as well as to shifts in political stance and priorities, prompting Chinese firms to reconsider their engagement strategies.

Effect of deglobalization

The principal value of globalization is increasing economic ties between markets and countries in terms of trade, travel, and investment. Global value chains have been established, driven by the investment activities of transnational corporations involving many countries that are all built upon a global mindset. However, this mindset is changing.

The trend toward deglobalization can be seen across the developed world – the China-US trade tensions for example – and its effects reverberated across Chinese companies in the form of shorter supply chains and decreased trade and investment. 

From a peak in 2016, China’s ODI flows and announced greenfield investments have been declining. They took a global nosedive in 2017, dropping from a combined US$196.2 billion in 2016 to US$158.3 billion. In 2018, Chinese ODI fell further to US$129.3 billion, with investment into North America and Europe being hit particularly hard, falling a combined 73%1 from 2017. The first half (H1) of 2019 brought more of the same, with ODI shrinking to US$57.4 billion, a decrease of 8.4% YoY.

These decreases are being driven by an environment where globalized trade is under threat and cross-border investment controls are becoming increasingly stringent.

Price of protectionism

The Chinese Premier, Li Keqiang, speaking at the World Economic Forum in 2018, laid out China’s position succinctly: “It is essential that we uphold the basic principles of multilateralism and free trade.” However, the trend toward protectionism in developed countries has resulted in the opposite, making Chinese ODI in these markets more difficult. For example, between 2017 and 2018, a total of 49 explicit restrictions or regulations relating to foreign direct investment (FDI) were introduced in 28 countries outside China, with nearly 40% of them deriving from national security concerns about foreign ownership of infrastructure, technology, real estate, and elements of the defense sector. 

The knock-on effect of the global regulatory developments has an impact to the M&A environment for Chinese enterprises abroad. Evidence of this can be found in the increase in lapsed or withdrawn Chinese M&A deals, which in 2018 represented a record high of US$37 billion in lost value. The majority of these lapses or withdrawals occurred in the US, with 75% of them taking place in the TMT, financial services, oil and gas, mining and metals, and advanced manufacturing and mobility sectors.

Risk of overconcentrated ODI targets

With the onset of protectionist policies, open markets are now closing doors. Consequently, Chinese enterprises need to diversify their trade and investment targets, lest their global competitiveness suffers. 

This risk can be seen in how concentrated China’s exports are, with the top five categories – appliances and electronics, textiles, base metals, manufactured goods, and industrial products – comprising 74.4% of all exports in 2018. Moreover, the US is the top export destination for each of these categories. Given the uncertainties and the US administration policies, sole reliance on the US market could pose risks to Chinese exporters, particularly smaller enterprises with less bargaining power. 

Action plan for Chinese ODI

Despite the challenges described above and the changing environment, in 2018, China was the world’s second-largest outward investor after Japan, as well as the third-largest economy in terms of ODI stock, trailing only the US and the Netherlands. Its percentage of global ODI stock was 6.3% in 2018, up from just 1.2% in 2008, an increase indicating China’s “going abroad” intentions. The question is therefore not whether, but how enterprises internationalize.

“Going out” and “bringing in”

China’s economic opening up set the country off on a path of development unprecedented in pace and scale. The welcoming of FDI has been central to this, bringing to China frontier technology and value chains that have helped to advance its industries. 

This has resulted in a shift in the quality of China’s exports, from lower-tier to high value-added products, many of them spanning the entirety of their industry value chains such as telecommunications equipment and electronics.  

As Chinese firms invest abroad – “go out” – there is a corresponding opportunity to “bring in” value chain elements through M&A activities. This process can avoid the risk of having a portion of a firm’s value chain stuck in a market with protectionist policies in place. At the same time, enterprises should not pursue M&As in markets where the risk of lapse or withdrawal is high.

Broadening ODI destinations and sectors

For China’s going out and bringing in strategy to work effectively, broadening its ODI destinations and sectors is crucial. This will decrease reliance on a single market and allow China greater capacity to adapt to increased geopolitical risks.

One focus area should be the markets for the Belt and Road Initiative (BRI). With deglobalization in the developed world prompting closer ties among developing countries, the BRI presents an increasingly attractive environment for Chinese ODI, particularly in Africa. Paul Kagame, President of Rwanda and rotating chair of the African Union, during the 2018 Forum on China-Africa Cooperation, said: “Africa is not a zero-sum game. Our growing ties with China do not come at anyone’s expense. Indeed, the gains are enjoyed by everyone who does business on our continent.”

Another focus should be sustainability. As green concerns have driven the development of regulations governing corporate behavior and green investing, China has begun mandating environmental, social, and governance (ESG) disclosure for companies. This can be seen in the 2018 promulgation of the Code of Corporate Governance for Listed Companies, as well as in the development of the Green Investment Principles for the Belt and Road.

Proactively managing trade frictions

Given the dual trends of deglobalization and protectionism, trade frictions are inevitable. These tensions require sound management of global trade operation and strict control over trade-related costs. Diversification is key in times of trade and investment uncertainties, and Chinese enterprises should be actively positioning themselves to be adaptable. 

To do this, for example in the context of companies looking to mitigate the risks of the China-US trade war, there are five areas enterprises should monitor: increases in tariffs on imported goods, increases in corporate exchange risks, threats to current supply chain arrangements, any rise in uncertainty in the external investment climate, and the introduction of tariffs with more stringent compliance requirements.  

When trade frictions occur, the first step is to perform an impact analysis, followed by an investigation into the available and most prudent mitigation techniques. Effective adaptation requires a combination of speed and accuracy. During times of trade and investment uncertainties, such a response is essential to remaining competitive.