Time for Action: Chinese Companies and “One Belt One Road”
By Xue Gong

Time for Action: Chinese Companies and “One Belt One Road”

Jun. 10, 2016  |     |  0 comments


China is ramping up its efforts to strengthen its influence, especially through economic means. Its “One Belt One Road” (OBOR) program is considered a major initiative for stimulating China’s trade with its neighbors, internationalizing its currency, and promoting goodwill.


The OBOR aims to help improve infrastructure and interconnections with China’s neighboring countries and those along the routes. The feasibility of this endeavor hinges upon China’s enormous economic leverage and export of its capabilities of infrastructure development to the neighboring countries. China has advanced technology in high-speed trains, nuclear power, aviation, telecommunications, and textiles. The saturated domestic market compels China to export these capabilities to fuel its economic growth. Particularly, China’s Asian neighbors are facing shortages of capital and technology. By satisfying the needs of the target countries, China can help its companies to expand overseas and climb up the global industry value chain.


To support the OBOR, the Chinese government has launched a USD 40 billion Silk Road Fund that directly supports the OBOR in collaborative projects related to infrastructure, energy, industry, and finance. The Asian Infrastructure Investment Bank (AIIB) was also established in October 2014 with a proposed initial capital of USD 100 billion to finance infrastructure projects along the OBOR.


While OBOR shows promise for Chinese companies grappling with domestic overcapacity and barriers to investment, institutional challenges remain. In particular, the management system for optimizing the efficiency of outbound direct investment (ODI) is still lagging behind the pace of ODI itself.


China’s ODI: Incentives with Restrictions


Before 2000, China’s ODI was hampered by a cumbersome administrative system. Complicated procedures were imposed on companies seeking approval. After the “Going Out” policy was introduced in 2000, supporting policies were swiftly implemented by the State Council, the Ministry of Commerce (MOFCOM), and the National Development and Reform Commission (NDRC). The NDRC simplified the approval procedure allowing enterprises to take full responsibility for their own benefits and losses in overseas investments. In particular, it abolished the requirements for project proposals and feasibility reports, and focused mainly on the examination of investment entities, investment directions, and compliance. Later in 2009 and 2011, the national authorities further relaxed the restrictions on ODI. It gradually decentralized the authorization power, simplified the authorization procedure, and improved authorization efficiency.1


Policy reforms that encourage overseas investment have an influential role in helping China’s enterprises go abroad by transforming them from global manufacturers to global investors. The shift in roles has implications for the sectors and geographic distribution of Chinese ODI. Driven by lax policy and regulations and a simpler administrative system, private companies are also joining the state-owned enterprises (SOEs) to expand globally.



The problem of fragmentation in regulation and supervision amongst different government agencies, compounded by a lack of legislation for the misappropriation of overseas investment, needs to be fixed.



Under the newly revised Measures for Foreign Investment Management in 2014 by the MOFCOM, the administrative procedures for overseas investment have been further simplified from an assessment-and-approval system to a registration-and-filing system. This enables companies to focus more on their goals while operating according to their strategies. Compared to the West which has progressively reduced the government’s involvement in companies’ activities, the Chinese government still has major control of its enterprises.


The central government’s recent announcement of relaxed administrative and approval procedures for private companies has been encouraging. It portends the gradual demise of SOEs’ favorable treatment from Chinese officials. Historically, the SOEs have enjoyed continued preferential treatment from the government, lowering the efficiency of Chinese ODI as a whole. The leading role for SOEs defined by the government in OBOR has also raised the question over how transformative the SOEs will be.2


Moreover, the problem of fragmentation in regulation and supervision amongst different government agencies, compounded by a lack of legislation for the misappropriation of overseas investment, needs to be fixed. The inadequate regulatory environment means that SOEs often operate in murky waters especially for their overseas investments, as there is no institutional supervisory body to oversee risky investments. Similarly, in the event of failed investment, there is no supervisory body to penalize irresponsible decision making and minimize any damage to bilateral relationships between the host country and China. It is common for shareholders and stakeholders to hold the CEO responsible for the performance of a listed company. But the same level of accountability does not necessarily apply to the CEO of a Chinese SOE. Handpicked by the Party, the CEO is subject to less scrutiny and can remain in the position with fewer requirements for accountability. Such an appointment mechanism creates loopholes for SOE managers to shirk responsibility to safeguard their political promotion.3 Under such a system, it gets increasingly difficult to prod SOE officials to focus on developing skillsets crucial for the development of the organization.


In contrast, private companies lack access to overseas financing and cross-border payment mechanisms.4 In order to secure project financing from domestic banks, they have to conduct costly assessments of investment risks and returns. At the same time, Chinese banks generally require Sinosure (China Export and Credit Insurance Corporation) insurance for overseas investments as a condition for their funding of projects. The higher insurance rates charged by Sinosure place Chinese firms at a disadvantage, compared to their Japanese and Korean counterparts.5 Furthermore, Sinosure also prefers to insure firms which have a sovereign guarantee. A sovereign guarantee allows Chinese projects operating in difficult jurisdictions to have sovereign support in cases of crises or wars that are potentially crippling. Therefore, SOEs with strong sovereign support usually obtain approval more easily.6


In order to grow, private companies are compelled to place more emphasis on generating cash flow than on ensuring the quality of earnings, thus resulting in short-term plans and inferior risk management. Such haste in generating cash flow can lead to inadequate understanding of the investment environment, culture, and customs of the target countries, and even violation of laws. For example, the Chinese tend to win construction contracts by bidding low. In order to make their project feasible, they have to reduce cost by lowering quality. Such behavior poses the risk of damage to the international image of China and its companies.


Challenges for Chinese Businesses


In addition to these inherent inefficiencies, Chinese businesses also have to grapple with external challenges. Regional conflicts, innovation capacity, and foreign mistrust of China are a subset of the long list of issues that makes the realization of OBOR a very complex endeavor.


First, China’s economy has been characterized as a growth-centered economic development model, which emphasizes economic rationalism and short-term speedy wealth accumulation. Because of this, the Chinese market lacks a credible system that encourages high-end production and consumption-based environment. In other words, innovation is in rather short supply. According to an inter-brand ranking that measures the value of global companies to society, there are only two Chinese companies, Huawei and Lenovo, which rank at 88 and 100 respectively.7 Investment in the OBOR infrastructure plan is considered as a means of moving up the value chain by transferring China’s low-end industries to less-developed countries. Therefore, China’s capacity in creating innovation for the economies of the target countries is questionable.


Second, Chinese firms do not have an impressive list of corporate social responsibility (CSR) activities as exhibited by more savvy firms from other countries. There are concerns that Chinese companies may not uphold existing international standards of environmental protection, human rights, and governance in their OBOR operations. Many Chinese companies are influenced by their own experience back in China. Subsequently, they usually pay limited attention to the social and cultural context of the host country. For example, it is common to incentivize local workers with monetary compensation for overtime or intensive work in China. Yet such monetary compensation might not be compatible with the local practices in the host country.



China concentrates on state-to-state deals that overlook the sustainable development of the local community. China is often criticized both for neglecting the local people’s needs and for a lack of transparency in its practices.



Third, the OBOR illustrates the elite-oriented trait of China’s investment approach. An elite approach means that China concentrates on state-to-state deals that overlook the sustainable development of the local community. China is often criticized both for neglecting the local people’s needs and for a lack of transparency in its practices. A predilection for volatile regimes has made China especially vulnerable to overseas political turmoil. For example, China’s substantial investments in Myanmar suffered a heavy blow due to the political transformation of the Myanmar government. China has to confront a new set of risks posed by shaky political regimes, volatile emerging markets, and other factors beyond its control. The Economist Intelligence Unit (EIU) reported in 2015 that a significant portion of China’s investments have flowed into Afghanistan and other shaky regimes where operational risks are much higher.8


Lastly, the rapid rise of China’s ODI in the past decade has met with resistance in some countries, due to negative externalities associated with these business activities. Chinese SOEs usually invest in strategic sectors such as energy and resources that can easily evoke economic nationalism. Chinese domestic subsidies provided to SOEs cast doubts on their status as commercial entities and engender security concerns in the host countries.9 This has led to debates within the host countries whether the perceived security concerns should take precedence over economic interests.


Time for Action: Beyond “Going Out”


Most Chinese ODI firms loosely abided by the law before venturing abroad. The Chinese legal system and requirements on business ethics — especially with regard to environmental protection — are relatively underdeveloped compared to those of the advanced economies. Unless relevant laws and regulations are issued, it is likely that Chinese firms will continue their malpractices overseas.


According to Zhao Lei, it is equally important for Chinese companies to not only “Go Out” but also to “Go Into” in order to have a favorable OBOR outcome.10 This requires the Chinese companies to bring corporate governance into their operations and adapt to the changes of the investment destination. Corporate governance is believed to bring significant added value to shareholders while recognizing the interests of other important stakeholders. Corporate governance confers significant advantages in building a company’s reputation and image overseas.


It is imperative that the government diversifies financing channels for Chinese firms and also encourages banks to provide equity financing, loans, and offshore financial services. Cooperation between companies should also be encouraged to create synergy, particularly between private companies and SOEs. The government should take an active role in complementing companies’ forays overseas by providing training and guidance in overseas risk control and management.


China is no different from other countries in wanting to build long-term relationships with the host countries. OBOR exemplifies this ambition. In order to achieve this, China must cooperate with different governments, companies, and investment fund managers, to create opportunities for shared projects and public-private partnership (PPP) initiatives.


China is lagging in its contribution to global governance. Shambaugh has called China a “partial power” and argued that China has not actively tried to solve global problems beyond its immediate interests, despite its global reach.11 However, the Chinese government has gradually taken measures to ensure that its ODI enterprises do not hinder its objective of economic diplomacy. As China’s economic activities continue to expand around the world, it is believed that China will gradually conform to the international social, business, and legal norms established in advanced economies.


The writer is hopeful that current issues stemming from problematic investments are transitory. Current signs indicate that China is still learning as it undergoes structural economic reform.


Notes


1. In 2009, MOFCOM published “Management Methods for Overseas Investment” and in 2011, NDRC issued “Notice on Decentralizing the Authorization Power in Overseas Investment."


2. Zhongguo Qingnian Bao: Yidaiyilu shang guoqi yao jingti naxie keng [China Youth Newspaper: What pitfalls SOEs ought to be alert along OBOR]. (2016, April 18). SASAC. Retrieved from http://www.sasac.gov.cn/n86302/n86361/n86401/c2292476/content.html

Jieli Yidaiyilu, guoqi guojihua maijin xinshidai [ Stepping into the new era: Internationalize SOEs through OBOR]. (2015, July 22). Deloitte. Retrieved from

http://www2.deloitte.com/content/dam/Deloitte/cn/Documents/process-and-operations/deloitte-cn-soe-transformationseries-issue3-zh-151020.pdf

Yidaiyilu shang guoqi zenme danghao zhulijun he lingtouyang [How SOEs can become main force and leader in OBOR]. (2015, August 3). China Youth Newspaper. Retrieved from http://www.scio.gov.cn/ztk/wh/slxy/31215/Document/1443108/1443108.htm


3. Rein, S. (2014). The End of Copycat China: The Rise of Creativity, Innovation and Individualism in Asia. New Jersey: Wiley.


4. Cisse, D., Grimm, S. and Nolke, A. (2014). State-directed multi-national enterprises and transnational governance: Chinese investments in Africa, corporate social responsibility and sustainability norms. Discussion paper, Center for Chinese Studies, Stellenbosch University.


5. Zhao, L. (2015, May 29). Yidaiyilu xuyao shenmeyang de Zhongguo qiye [What kind of Chinese companies are needed for OBOR]. Sina. Retrieved from http://finance.sina.com.cn/zl/china/20150529/081522296737.shtml


6. Norton Rose Fulbright. (2016). Tapping Chinese belt and road capital for power projects: Ten things to know. Retrieved from http://www.nortonrosefulbright.com/files/tapping-chinese-belt-and-road-capital-for-power-projects-137672.pdf


7. Interbrand ranking. See http://interbrand.com/best-brands/best-global-brands/2015/ranking/


8. The Economist Intelligence Unit. (2015). Prospects and challenges on China’s One Belt, One Road: A risk assessment report. Retrieved from http://www.eiu.com/Handlers/WhitepaperHandler.ashx?fi=One-Belt-One-Road-report-EngVersion.pdf&mode=wp&campaignid=OneBeltOneRoad


9. Scissors, D. M. (2014, July 9). Chinese global investment growth pauses. American Enterprise Institute. Retrieved from http://www.aei.org/publication/chinese-global-investment-growth-pauses


10. Zhao, L. (2015, May 29). Yidaiyilu xuyao shenmeyang de Zhongguo qiye [What kind of Chinese companies are needed for OBOR]. Sina. Retrieved from http://finance.sina.com.cn/zl/china/20150529/081522296737.shtml


11. Shambaugh, D. (2013). China Goes Global: The Partial Power. Oxford University Press.

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