Restricting Chinese FDI into India: How China Uses Financial Crisis to Further its Expansionist Agenda

In a move that follows many members of European Union, and one that could have an impact on relations between India and China, the Government of India announced that it was amending the foreign direct investment (FDI) rules through the automatic route for countries that share a border with India.

The restrictions, already in place for Pakistan and Bangladesh, will be extended to companies where citizens of China have ‘beneficial ownership’, thus ensuring that investments through the automatic route do not find their way through countries like Singapore, Hong Kong, or Mauritius.

The move followed the news of People’s Bank of China increasing its stake in one of the biggest private banks of India, HDFC, from 0.8 per cent to over 1 per cent.

As companies, across the world and in India find themselves grappling with the outbreak of the coronavirus, possible long-term losses, and deflated market capitalisations, the move from the government could not have been more well-timed for a number of reasons, given the trends witnessed globally.

If the financial history of the last 25-years is taken into account, the nation of China has always emerged as a winner from any unprecedented global crisis.

When the Asian crisis of 1997-98 struck, China was emerging as the factory of the world, thus making it ideal for global investments. The then investments by the West followed a reward for China in the form of the World Trade Organisation (WTO) membership in late 2001.

After the stock market crash and the consequential ‘Great Recession’ of 2008, while the markets in the United States were falling, investors turned to China to recover their losses that had followed the crash of Lehman Brothers.

By this time, China had moved beyond merely being a hub for cheap finished products and promised a booming economy as the West struggled to make sense of the slowdown.

The government of China too fueled this boom by making mighty investments in the infrastructure sector. Between 1995 and 2015, China witnessed the migration of over 330 million people (more than the current population of the US), from villages to the urban hotspots, thus justifying the creation of one city after the other, some modelled on cities of the West.

The construction boom further created a demand for commodities like steel, cement, coal, and other industries like wind, fertilisers, and so forth.

Between 2006 and 2012, around 400 companies from China found their way to the stock exchanges in the US. However, 80 per cent of these companies were ‘reverse mergers’.

Small-time Chinese companies no one had heard of partnered with shell companies in the US that were listed on the stock exchange but existed only on paper in terms of operations, thus facilitating a reverse merger. This gave these small companies from China access to investors in the US who were looking to make a quick buck to overcome their losses from the 2008 crash.

While the presence on any US stock exchange validated the existence of these Chinese companies, the investment firms in the US milked the trade on these shares through hefty commissions.

Auditors in the mainland, masquerading as the Chinese face of the global auditing firms, further validated the claims made by these companies who were listed in the US but supposedly had operations in China.

As banks had used rating agencies in 2008 to validate the financial instruments like credit-default swaps (CDS) and collateralised debt obligations (CDOs), China began using auditors and investment firms in the US to drive capital from the US to China, and thus use the calamity of the West as an opportunity of its own.

Eventually, the bubble was busted as companies inflating their revenues by ‘n’ number of times could not keep up with the investor sentiment. Many companies sank and with them sank wealth worth $14 billion that belonged to the American people in the form of pension and retirement funds.

The world, however, has moved on, and today, more than 100 big companies are trading on the US stock market with a market capitalisation that is more than trillion dollars.

China, too, has moved on. From using the slowdown as a way of attracting Western capital to its inflated enterprises, it is now looking to embark on a strategic investment spree in companies critical to the West.

As the global slowdown pushes share prices of companies down, China is looking to go on a shopping spree in the season of an induced artificial sale.

According to a report in Bloomberg, bankers in Europe have seen a spike in requests from Chinese funds and other state-owned enterprises for shares in companies, thus aiding its Belt and Road Initiative.

China’s interest is complemented by many factors.

Firstly, the MSCI Europe Index that tracks the performance of 15 developed markets across Europe collectively is 23 per cent down, thus showcasing the vulnerability of many companies struggling for cash.

Two, there is little competition from the US as it has now become the epicentre of the virus itself, thus leaving enough room for China.

The companies in China have not shied away as well from voicing their interests to invest globally. Many state-owned enterprises of China are often on the hunt for companies in futuristic sectors like energy, technology, and automobiles.

Only recently, as per a report, CNIC Corp, an investment fund backed by the Chinese government was eyeing a 10 per cent stake in Greenko Group, one of the largest companies in India in the renewables sector.

Quite like India, Europe has woken up to the threat of Chinese investments as well.

In March, the European Commission called for its member states to protect strategic assets and other sectors from significant investments that could derail policy initiatives or put Chinese interests before that of the member states itself.

Italy, one of the worst-hit nations in Europe, is employing measures to restrict foreign takeovers across sectors that include banking, insurance, energy, and healthcare.

Last month, Spain too tweaked its rules of foreign direct investment, stating that any new investors outside the EU would require government authorisation if they were looking to increase their stake by more than 10 per cent in any local company, both public and private.

Germany’s chancellor Angela Merkel is also deliberating on similar measures to curb investments by China.

Even before Covid-19 took over, China had been buying its way into Europe. After the global recession, China had invested more than $318 billion across Europe.

The United Kingdom saw more than 220 deals of around $70 billion, Italy and Germany had deals worth $31 billion and $20 billion respectively, across sectors ranging from technology to airlines.

In what can be termed as one of the biggest deals in Europe, China National Chemical Corp announced the takeover of pesticide manufacturer Syngenta AG, based in Switzerland, for $46.3 billion in 2016.

As per the data compiled by Bloomberg, across Europe, close to 360 companies were taken over, and partial or complete ownership was extended to four airports, six seaports, and 13 professional soccer teams. Investments by state-owned enterprises of China alone constitute more than $165 billion worth of investments.

Across the world, between 2007 and 2017, China has made deals worth $155 billion in energy, $102 billion in finance, $75 billion in mining, close to $50 billion in internet/software and utilities each, close to $60 billion in chemicals, around $45 billion in logistics, and worth of $5 billion deals in aviation alone. These investments do not factor in the deal routed through third-party investment funds or countries.

India is no different from Europe. While the inflow of investments from China may not have been as tremendous as it was in Europe following the ‘great recession’, they have followed an upward trend, especially since 2014.

As elaborated here, China’s private firms with questionable ties to its government have been heavily investing in India’s technology sector, mainly startups in the ecommerce sector like BigBasket. However, the investments are not constrained to technology alone.

Other sectors include pharmaceuticals, infrastructure, energy, automobiles, consumer goods, and real estate. In 2016 alone, infrastructure investment in India was close to $6 billion, and more than $3 billion in energy in 2018 amongst other sectors.

Some of the biggest investments in India have been led by Alibaba, Tencent, Xiaomi, along with other state-owned enterprises like China Railway Rolling Stock Corporation (CRRC) which had been awarded a 10-year contract to supply 69 coaches for the Nagpur Metro and 112 coaches for the Kolkata Metro.

The amendment in the FDI rules does not go against the spirit of open-markets, which the Modi government has always been inclined to.

Given how startups funded by Chinese giants have been crucial employment drivers for the lower-income groups, their importance to the business ecosystem cannot be negated, and a case to completely thwart their investments in India must not be made.

Yet, it is in the best interests of India to learn from its counterparts in Europe who have been late to realise the economic, social, and political magnitude of Chinese investments in the region. A lesson is warranted from the US too, which after 2008, saw shell companies through reverse mergers deceiving their investors.

China has a history of using recent slowdowns to further its interests, and therefore, India’s move to amend FDI rules, merely after a week after HDFC news, caters to both, the spirit of open markets and interests of domestic enterprises. Unlike Europe, India must not be a cakewalk for China’s enterprises.

This is the second article in a multi-part series on strategic investments by China’s state and private firms across the world and their economic and political significance in a post-Covid-19 world. Read the first one here.