China leveraged its success on international trade and finance to promote OFDI through bundling
By Surjith Karthikeyan
A recent report by US AidData, reveals inter alia ‘hidden debt’ in Chinese development projects worth $843 billion, highlighting Belt and Road Initiative (BRI) implementation problems. Outward Foreign Direct Investment (OFDI) from China witnessed a 3% decline (as per the World Investment Report 2021) and scaling back of public investment (IMF World Economic Outlook 2021). This necessitates a review of China’s FDI strategy for the last 20 years.
FDI is a cross-border investment aiming at enterprise management, diversifying risk and improving efficiency. While it increases productivity and employment opportunities, its benefits depends inter alia on factors like governance quality, policy distortion, foreign exchange stability, investment skills, money laundering and related risks. FDI typically flowed from advanced to developing countries due to technology and wage gaps. However, it has seen recently a surge from developing countries, especially China, exploring new growth engines, viz. high technology and valuable trademark. China mobilised inward FDI by opening up its coastal cities and SEZs, targeting export-oriented manufacturing way back in 1990s, and shifting to service sector after World Trade Organisation formation in 2001, justified by its comparative advantage in capital and labour. Policy support through tax reduction, preferential treatment on loans, land, licence, etc, led to reallocation of factories to coastal cities (Hong Kong and Taiwan), rapid economic growth, high return for investors and massive hoarding of international reserves. China’s FDI strategy changed after Global Financial Crisis (GFC) due to slowdown, weak demand and lacklustre export-led growth, evolving from rising labour and capital costs. The liquidity constraint, coupled with falling asset price, and increased purchasing power of international reserve, motivated it to adopt OFDI. WIR 2016 reveals it as one of largest outbound direct investor in 2015 ($127.6 billion).
China promoted OFDI through multinational management experience and technology development through imitation and innovation. China, then, was also a key player in international trade, with a third of the world’s merchandise trade in 2011, having efficient export platform for manufacture goods and huge import demand for natural resources. China had a large net foreign-asset position with sufficient capital goods and liquidity and international aid/loan and credit lines. Thus, China leveraged its success on international trade and finance to promote OFDI through bundling, a marketing strategy to sell group of products/services as a package. Bundling a star product with a new one increased China’s market share, sales and efficiency.
China imported raw materials from Africa by accelerating mining, resolving transportation difficulty, infrastructure and logistics investment. It identified recipient country’s fund shortage and facilitated provision of capital goods, financial aid and liquidity, bilateral currency swap lines etc. Bundling OFDI with trade and finance increased China’s attractiveness to these countries. Studies reveal positive association of Chinese trade and finance with its OFDI, as their investments strategically target countries from where China imports commodities and exports manufacturing goods (Aizenman, Jinjarak and Zheng, 2018). The financial support to those countries strengthens the bundling effect. The positive relation between trade and OFDI is more pronounced after GFC for OFDI in tradable and natural resource sectors.
China embarked on bilateral currency-swap agreements after 2008, targeting emerging economies through credit lines, providing liquidity buffer, increasing resilience of financial system, and enhancing business confidence in both markets. When host countries face credit constraints, institutional challenges and commodity price volatility, China enhanced its market power by injecting liquidity and improving stability. The provision of swap lines improved bundling efficiency. The strategy of OFDI is heterogeneous across Chinese State-owned enterprise (SOE) and privately-owned enterprise (POE). Through preferential treatment, Bundling is made more efficient for SOEs, when leveraging market power. Political linkages among SOEs facilitated bundling. POEs have more bundling opportunities through provision of lower barriers, when dealing with nationalism government, enabling flexibility and motivation to be bundled. Studies reveal that SOEs dominated before GFC while POEs caught up after 2012.
Presently, OFDI from China is 133 billion, retaining its position as the largest investor in the world (WIR 2021). The value of cross-border M&A purchases by Chinese MNEs doubled, mostly due to financial transactions in Hong Kong. Continued expansion of the BRI also led to resilient FDI outflows amid pandemic. However, there are reports on serious debt crisis in China coupled with proposed default in its property sector. Also, the unusual confidentiality clauses in Chinese OFDI contracts bar borrowers from revealing even the terms or existence of the debt. The intensity of the crisis however, shall be evident in the days to come.
The author is Deputy secretary, ministry of finance
Views are personal