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Regulatory headwinds impacting on Chinese offshore investment levels in 2017

On reflection, 2016 was a mixed year for mergers and acquisitions (M&A) globally, given the political and economic uncertainty in many parts of the world and the greater scrutiny of mega cross-border deals. Based on these factors alone, one may have expected a decline in M&A levels.

However, there was certainly no slowdown in Chinese outbound investment in 2016. Having broken many M&A records in the preceding years, China’s outbound investment surpassed that of the United States for the first time in 2016. This made China the global leader and another milestone for an expanding global M&A powerhouse.

However, with a sharp decline in both deal volumes and deal values in the first quarter of 2017, uncertainty has been raised on the performance of M&A markets in Greater China in 2017.

Outbound investment in 2017

Regulatory headwinds are dampening expectations for the performance of M&A levels in the Greater China market in 2017. In Q1 2017, we have already seen total Chinese mid-market M&A deal volumes decline, falling 17% compared to the same period in 2016. Compared to Q4 2016, a 54% decrease in midmarket deal volumes and a 24% fall in deal value were reported.

The slowdown partly represents a typical seasonal trend driven by the economic slowdown during the Chinese New Year period. But this slowdown also follows a tougher regulatory approval process on Renminbi currency controls, resulting in a decline in funds being moved offshore by both PRC corporations and individuals. Such regulations, introduced by the Chinese Government in late 2016, have raised concerns by overseas vendors on the ability of Chinese buyers to successfully raise funding to complete acquisitions.

We comment below on three key economic factors that may affect Chinese outbound M&A levels in 2017. While the Chinese government is still considered to be supportive of outbound M&A, restrictions have been implemented to stem the tide of outbound investment due to: i) the sharp decline in China’s foreign currency reserves; ii) growing levels of domestic debt; and iii) the depreciation of the Renminbi (RMB) against the global currency benchmark, the US dollar (USD).

China’s foreign currency reserves

Total foreign currency reserves held by China over the past 12 months is illustrated in Figure 1 below. The speed at which these reserves have fallen has been remarkable, with total reserves hovering just above a six-year low of US$3.01 trillion as at 31 March 2017.

Reserves have fallen partly as a result of China’s substantial overseas direct investments (with China becoming a net capital exporter in 2015) and partly due to the large movement of funds offshore by PRC companies and individuals, which has been driven by concerns over China’s slowing economy and anti-corruption clampdowns. As a result, the authorities have tightened capital controls to restrict currency outflows.

However, with foreign currency reserves still more than twice the size of Japan’s (the second largest in the world) and with China continuing to generate large monthly trade surpluses with most of its key trading partners, there may be no immediate concern in this area.

China’s growing levels of domestic debt

The growing debt levels of private and state-owned enterprises have raised concerns among market observers. With a significant proportion of outbound acquisitions funded by debt in recent years, any tightening of credit cycles will have an impact on the ability of PRC companies to fund acquisitions. Since 2005, there has been a boom in China’s overall debt as a percentage of GDP, and since the global financial crisis in 2008, there has been a year-on-year increase, with a cumulative average growth rate in debt levels of 54% over the last five years.

At the end of 2016, China’s debt stood at 258% of GDP. Some industry commentators have suggested that China’s debt levels may hit 300% of GDP in the coming years if current practices are continued, with mixed views on whether action should be taken now to address the growing debt burden.

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