Risky Business, Chinese Style

By Evan Feigenbaum

(Macro Polo) – Does China Inc. have a bottomless appetite for risk?

The question seems preposterous on its face because anyone who invests money should, self-evidently, be concerned with what happens to it once it changes hands. But so much of what’s being written these days about China’s growing global activism argues, at least implicitly, that Chinese government agencies and national champion firms are, at minimum, risk tolerant and, in some cases, perhaps even risk oblivious.

China, it is often noted, has pumped cash into places beset by corruption, plagued by awful business climates, fractured by social tension, riven by political conflicts, and, in some countries, overcome by civil war.

Consider this: China, according to The New York Times, has the distinction of being the number one foreign investor in “five of the ten riskiest countries in the world.”

Then there’s Beijing’s multitrillion dollar “Belt and Road” infrastructure initiative, which includes eye-popping pledges to more than a few countries where Western firms have feared to tread.

Last, there’s the disproportionate role played by Chinese state-owned enterprises in overseas mergers and acquisitions (M&A). Such firms are often said to be exceptionally risk tolerant because they are implicitly guaranteed against insolvency by the Chinese state.

But of course, like all simplified narratives, this one is, well, just a little bit too simple.

Beijing isn’t irrational. Neither are those who run its leading state and private companies. So they cannot possibly have a limitless appetite for risk taking. And certainly, China’s political leaders have their limits. Indeed, that’s one reason the state is now cracking down on at least some types of deals and other forms of capital outflow.

Yet the underlying question of whether and how China Inc. weighs various forms of risk has become more interesting. A decade ago, few Chinese banks or corporates had sophisticated risk analysis arms. Today, that is changing, with the beefing up of monitoring and compliance functions, consultations with international risk consultants, the establishment of formal risk assessment operations inside financial and corporate institutions, and the development of “risk rankings” and indexes by Chinese government-affiliated think tanks.

And that isn’t all. Political and public tolerance for excessive risk taking, real or imagined, has also worn increasingly thin. In the aftermath of the 2008 financial crisis, China’s powerful sovereign wealth fund, China Investment Corporation (CIC), famously came in for criticism for loss-making investments. The fund subsequently changed some of its investment strategies. And several leading Chinese companies have also been hit for taking poor risks, too many risks, or (from the vantage point of the Chinese state) the wrong kinds of risks.

In short, a new reality seems to be emerging: China cares far more for risk management and mitigation than many observers give it credit for. And since further evolution of risk management practices is in the offing, this will likely have some big implications for the way China interacts with the rest of the world.

Rising Risks, Changing Narratives

With China’s global role and investment profile certain to expand further, it’s worth asking a few exploratory questions about how China Inc. may—or may not—weigh risks as geopolitics, national politics in various countries, and advanced and emerging economies all become more turbulent.

For one thing, it’s worth asking why the popular narrative of a “boundlessly risky” China cohered in the first place. One reason, I suspect, is that it could superficially be made to stick to China on a variety of conventional risk measures.

Just take these two—corruption, and the ease of doing business:

Transparency International (TI), which publishes an annual corruption perception index, has ranked Somalia as the world’s most corrupt among 176 countries. But blink once and, hey presto, there’s China—signing oil and fishing agreements with the president of Somalia’s Puntland state, building airports, and donating reconstruction and flood assistance.

TI’s second most corrupt country? South Sudan. Now blink twice, and there’s China again—this time with investments in the oil sector and a prospective peacemaker’s role to boot.

The same could be said of “doing business” risks. The World Bank’s respected Doing Business index ranks Somalia again as the world’s hardest place to do business but authoritarian Eritrea ranks a close second. Blink a third time and “risky” Eritrea is no apparent deterrent to hardy Chinese investors. China is the country’s largest foreign investor, active in gold mining, agriculture, and the power sector.

But China’s sheer activism—merely being present in so many places—isn’t the end of the story. Another reason for the narrative of an endlessly risky China was the refrain, often heard in the American and European media over the last decade, that Beijing-backed investment packages arrived with “no strings attached”—in other words, that China was pretty much oblivious to risk.

Here are two mid-2000s examples, both from the venerable New York Times: In Chad, the Times argued in a 2007 photoessay, China was “drilling for oil, no strings attached.” In Sudan, the same paper told us, Western officials were increasingly concerned about the implications of China’s “no strings attached aid policy.” Ultimately, the paper argued, the debilitating effects of “no Chinese strings” could be seen all over the African continent.

But here was the problem:

China’s state-backed investment packages have always had strings, including during that decade of the 2000s when China began to step out on the global stage in new ways. Beijing has long conditioned certain export financing, tied credits, and some direct investments on an array of factors that might differ from, say, your average International Monetary Fund (IMF) standby program, but nonetheless do impose conditions.

In short, it was never true that the nature and quality of an investment (not to mention the policies of this or that country toward Beijing) were irrelevant to a Chinese decision to pump in cash.

Here’s an example that has implications for risk management: Despite all the talk about “no strings” in Beijing’s policy lending, China’s Export-Import Bank has maintained a requirement of 50% Chinese content (value-added) for its export seller’s and buyer’s credits, preferential loans, and export credits for ships. And China Development Bank, the country’s other large policy lender, has similar strictures.

Does this use of content-related conditionality promote the use of Chinese products? Sure it does. But it also reflects a modest effort to mitigate supply chain risks and fears of uncertainty by ensuring that Chinese firms can always source supplies, materials, and products from themselves, their Chinese partners, or others at home to whom they can turn.

It’s also the case that even the hardiest state-backed Chinese national champions will not simply go anywhere, pay anything, bribe anyone, or accommodate every impulse of every government merely to “lock in” a deal.

In fact, some Chinese firms have walked away from deals. One mining company notably did so in Pakistan in 2011 because of perceived security risks. And in countries like Guinea, local officials quickly got the message. “The political situation here is not very stable,” China’s ambassador Huo Zhengde lamented to The New York Times in 2009, and one Guinean finance ministry official responded separately that “the Chinese have changed their strategy. They are not going to inject $5 billion into an unstable country in an uncertain market climate.”

But if it’s now better recognized that China doesn’t just throw away its cash, then what precisely does lie behind the “strings”?

Do China’s government and firm-level choices reflect a political agenda, national security goals, a desire to mitigate economic risks, or perhaps a combination of all three?

My answer is that we are seeing the sprouts of a more sophisticated Chinese approach to managing—and then balancing—multiple forms of investment risk: geopolitical risks, political and physical security risks, and, of course, pure economic risks.

Evolution and Disruption

In my experience at least, the Chinese government has been wrestling with how to better manage overseas investment risks for at least a decade and a half.

In 2002, during President George W. Bush’s first term, I was the member of Secretary of State Colin Powell’s Policy Planning Staff responsible for East Asia and the Pacific. When the President launched the Millennium Challenge Account (MCA) in March 2002, shifting the focus of US development activity toward good governance and anti-corruption indicators, the new and more business-like approach got Beijing’s attention.

At a round of Policy Planning Talks, the Chinese blended a development discussion into a wider-ranging investment discussion, highlighting risks that Chinese firms and citizens were encountering around the world, including corruption and barriers to repatriating capital. This yielded questions from the Chinese side about assumptions and prospective requirements under the MCA.

Of course, this was eleven years before President Xi Jinping launched the gargantuan Belt and Road initiative. And the Belt and Road, because it is closely connected to strategic and political goals, may have short-circuited some of that new thinking. The initiative includes diverse projects in distinct sectors in the widely varying investment climates of dissimilar countries on at least three continents. That is a lot of diversity, and so it can be hard to generalize about implications at the project or business level. But one thread that runs through the entire Belt and Road effort is the huge topline pledges made by the Chinese government—for example, an initial $46 billion pledge for Pakistan in 2015. Government leaders, quite often, tie these to official visits. So they are developed within tight timeframes and in a largely political, not business, context. In some cases, this probably means a lack of sufficient diligence at the project level and inadequate attention to risks.

Not surprisingly, then, while risk assessment may not influence the topline, politically driven pledges, it comes into play once business and contract negotiations kick in.

Indeed, that is surely one reason that both pre- and post-Belt and Road projects have either not materialized (Myanmar hydropower, stalled by local opposition) or been delayed (Afghan copper mine, slowed by technical limitations, among many factors).

In several cases, the terms of specific deals have evolved in the aftermath of agreement. As Chinese technical and risk concerns have mounted, contractual disputes have emerged.

At the Aynak copper mine in Afghanistan, for example, contractual bargaining resumed years after the initial deal because the Chinese state-owned partner sought a renegotiation in five areas, including royalty payments, as its assessment of viability, costs, and timelines changed.

Then there’s the stark reality of security risks, which have hamstrung some projects and slowed others. Since 2014, for instance, militants trying to disrupt work on the China-Pakistan Economic Corridor have killed more than 40 Pakistani nationals. So the Pakistan government has had to raise a paramilitary force to protect projects in rural parts of Baluchistan, where the writ and reach of the police is constrained.

Ultimately, the pace, scope, results, and returns on these Chinese investments will vary widely at the project level—with technical, business, political, and security risks a major contributing factor.

Evolving Approaches to Risk?

Here are some things that bear watching:

First is the evolving relationship between the Chinese state and Chinese companies, both public and private, in the assessment of business risks, particularly overseas.

As Erica Downs has argued, “China Inc.” isn’t really a coherent entity—firms sometimes compete against each other overseas and rarely have a unitary agenda. But one thing that seems clearly apparent to me is that the Chinese state is the ultimate arbiter of risk—imposing or removing capital and regulatory controls, brokering specific investments, and sometimes restricting investments in certain sectors or countries while steering them toward others.

Public sentiment is one intriguing dimension of this calculus: CIC, for example, was bashed by “netizens” on the Chinese internet for losing “the people’s money” when returns turned negative and some investments went sour, first with stakes in global financial services firms and then on account of a commodities downcycle. Meanwhile, debt-laden economies have aggressively sought to attract a portion of Beijing’s considerable stock of investment capital. But investment in such environments has grown more difficult to sell domestically in China. As one pithy post on Weibo (a Chinese version of Twitter) put it a few years ago: “Better to save [debt-burdened] Wenzhou than to rescue [debt-burdened] Europe!”

But more significant than mere public outcry is the Communist Party and government’s own assessment of the political implications of certain economic risks. Chinese companies, even private ones, can still end up in the crosshairs if their investments are deemed “too risky” because they compromise the state’s other goals.

A second issue concerns tradeoffs—will Beijing willingly tolerate long-term loss making by public firms if an investment in this or that country, even a bad one, serves geopolitical and strategic goals? Here, the Afghanistan copper concession and some investments in Pakistan bear close watching.

Third, the Chinese government aims not just to leverage investment as a tool of statecraft but also to proactively mitigate political risks to Chinese firms through diplomacy and relationship building.

Just look at the Philippines: Beijing’s volatile relationship with Manila over the South China Sea has never precluded Chinese investment in that country, but the biggest deals have, unsurprisingly, coincided with the tenures of friendlier Philippine governments.

China’s State Grid Corporation took its 40% stake in the National Grid Corporation of the Philippines during the tenure of the comparatively friendly President Gloria Macapagal Arroyo. And Beijing has built an aggressive approach to deal makingand pledges of enhanced investment into its receptive stance toward the incumbent president, Rodrigo Duterte—a carrot dangled not just because of Duterte’s more accommodating stance on the South China Sea but also because Beijing assesses that his government offers a more reliable, Chinese investment-friendly partner in Manila.

Fourth, Beijing seems certain to take investment risks much more seriously as its companies’ global profile expands.

The risk product for 57 countries developed by the Chinese Academy of Social Sciences may be instructive here. For 2017, it tags some countries that are lessfriendly to China strategically as some of the best and safest places for Chinese investment, while tarring China’s closest diplomatic and strategic partners, such as Venezuela, as the “riskiest” investments.

The United States, ranked 30^th on various measures of “relations with China,” not surprisingly ranks 2^nd as a safe investment.

Pakistan, ranked as China’s very best relationship, nonetheless scores 33^rd on overall investment risk, below Turkmenistan and Cambodia.

And this highlights a critical point. Since the 2008 financial crisis, there has been a notable shift in China’s risk appetite. Thus the top destinations for Chinese foreign direct investment are, in fact, stable, predictable, low risk, advanced industrial economies, including the United States, Singapore, Australia, the Netherlands, Canada, and the United Kingdom. That is where numerous Chinese firms, especially the private ones, are diversifying their portfolios.

Fifth, as China develops greater sensitivity to investment risks, there may be room to coordinate, and possibly collaborate, even on some of the traditional risk factors, such as corruption.

One context is, obviously, the new Asian Infrastructure Investment Bank (AIIB)—a Beijing-backed vehicle, to be sure, but one that has evolved into a new multilateral development institution, with potential feedback mechanisms into China’s own national institutions, standards, and practices for its bilateral lending.

As my former boss and ex-World Bank president Bob Zoellick has argued, there’s a prospective agenda for institutional learning and standard setting in the context of the AIIB, and this should logically include such issues as anti-corruption, transparency, and governance. Zoellick has noted, for example, that the World Bank did much the same with Islamic and Arab funds, regional banks, and private sector players, and he has argued that it could do this now with the Beijing-backed vehicles.

Here’s the punchline: I think we’re on the cusp of some new ways of thinking about risk among Chinese entities, both government and corporate.

Chinese money generally follows the flag, so it’s often implied that geopolitics is everything—in other words, that Beijing will simply throw money around anywhere and everywhere to support its strategic aims. But some trends suggest that Beijing is becoming vastly more sensitive to investment constraints and macroeconomic conditions.

And frankly, that is a good thing.

China may now take a path previously traveled by other Asian tigers, and even the United States, Japan, and some in Europe. Governments and investors grow cautious and conditional as they gain experience in new areas of activity. But before that happens, they can look awfully profligate. Like others before it, China often looks that way today but on a larger scale.