August 21, 2017 / 7:24 AM / a year ago

China's M&A controls trap firms in a warped market

HONG KONG (Reuters Breakingviews) - Beijing has officially put its foot down on foreign takeovers of hotels, sports clubs and other sectors it deems “irrational”. Some argue this was prompted by worries about bad debts resulting from silly deals. Perhaps, but the crackdown misses the root issue: domestic distortions that encourage companies to offset low profit margins at home with racier investments abroad.

The shadow of a participant is seen on a map illustrating China's "One Belt, One Road" megaproject at the Asian Financial Forum in Hong Kong, China January 18, 2016. REUTERS/Bobby Yip

The curbs, unveiled late on Friday, confirm what has been apparent for months, as the state has put increasing pressure on high-profile acquirers of foreign assets such as Anbang Insurance, Dalian Wanda, Fosun and HNA.

The retreat marks a return to an already conservative position. Despite big headlines and some wacky buys, China’s overseas investment stock stood at only $1.3 trillion in 2016, according the United Nations Conference on Trade and Development. Outbound flows touched a record $183 billion that year - less than 2 percent of the country’s GDP. The domestic financial system generated roughly the same amount of credit in July. For all the talk of debt worries, Chinese mergers and acquisitions do not pose a systemic risk.

There are two historical reasons China is underinvested overseas. First, capital controls forced firms to jump through numerous hoops before closing deals. Second, blistering growth made it more profitable to invest at home. But direct investment is a major tool of diplomatic influence, so Beijing was dissatisfied with this situation. Regulators sharply reduced approval requirements, and transactions rose.

However, there were less liberal forces at work. One side effect of cheap money at home has been overcapacity, as state-linked firms using cheap credit enter new markets willy-nilly and drive down profit margins. This caused many Chinese executives, facing dismal returns from core businesses, to seek other places to earn profit. Some went into financial speculation, which officials called “casting off the real for the empty”.

Others, more sensibly, tried to escape domestic price wars by expanding overseas. For example, China’s bike-sharing startups ofo and Mobike, watching the streets of Chinese cities clog with copycats, are quickly building footprints in European and U.S. cities where they can charge more. This also arguably holds true for deals like Anbang’s purchase of the Waldorf Astoria; China’s hospitality sector is also cut-throat.

Overseas deals are not guaranteed to succeed, but discouraging them is unhealthy. By denying corporations viable opportunities to put money to work offshore, Beijing damages competitiveness. That will ultimately make the debt problem worse, not better.


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