Notes

The Michael Shearin Group Morgan Stanley Paris Deals Europe catches the third wave of ODI from China

The Michael Shearin Group Morgan Stanley Paris Deals
China Inc is going shopping, but its target is shifting from resources and infrastructure to services and manufacturing technology - and Europe is likely to be the main beneficiary.

Despite the size of its economy, China is a small player in overseas direct investment, accounting for 12 per cent of global output, but just 2.1 per cent of global direct investment, according to HSBC Global research.

That is changing. Outbound direct investment (ODI) increased 16.8 per cent to US$90.17 billion last year, while foreign direct investment (FDI) rose just 5.25 per cent to $117.59 billion. ODI will likely surpass inbound FDI in two years as China moves nearer to its long-pursued goal of achieving balanced capital flows.

The first wave of China ODI went principally into primary industries, dominated by coal, oil and metals, as China's fast-growing economy is not rich in natural resources.

The second wave was investment in infrastructure, including rail, shipping and ports.

It is natural for these two waves to be closely linked because it is difficult to reap the full benefit of investment in commodities without having good transport links.

Today we are seeing the third wave. The growth rates in natural resources and infrastructure investment are tailing off, and the acceleration is now in goods and services. Last year, of total non-financial ODI, 32.7 per cent went to business services, 22.4 per cent to mining, 15.2 per cent to wholesale and retail, 9.6 per cent to manufacturing and 7.2 per cent to construction.

China's ODI in goods and services is dominated by three industries - automobiles, telecommunications and consumer staples, mainly food producers.

Chinese companies seeking to move up the value chain are buying Western manufacturers not just for their brands, products and market share, but also for the intellectual property and skills tied up in the manufacturing process itself.

Mergers and acquisitions could accelerate the internationalisation of Chinese companies in Europe. There have been a few significant deals, but the total size has been small. The expectation is that more transactions will come.

State-owned enterprises are playing a smaller role in international acquisitions as the private sector gains momentum. The state sector reduced its acquisitions in Europe from $11 billion in 2012 to $4.4 billion in 2013, but companies almost doubled their investments from $964 million to $2 billion last year.

Trade between Europe and China has grown by more than 500 per cent over the past decade, but investment flows have lagged.

The improvement in labour and product market flexibility in at least some European Union countries is making more of Europe look attractive.

Spain stands out, having undertaken more labour market reforms than Italy or France.

The stabilisation of the broad European economy and the return to GDP growth in most countries will help underpin ODI from China.

Chinese companies are eyeing Western Europe, and they are becoming more active in Central and Eastern Europe and the Mediterranean, where the eurozone crisis has pushed labour costs down and created opportunities for foreign investment.

China has announced an ambitious plan to invest $100 billion a year in Eastern Europe by next year - a target, if achieved, would give a significant boost to the eurozone recovery.

Investment and acquisition to support Chinese companies expanding in Europe are new activities for Chinese banks, as demand for a wide range of sophisticated financial services is always increasing.
London, Paris and Luxembourg are among the first priorities for Chinese banking expansion, as Chinese companies have deep trade and investment connections in these economies. Luxembourg, for example, has received the most outbound investment from China and will likely become a base for yuan product evolution for Chinese banks.

China is in the midst of a structural shift from a country that has been a recipient of inbound investment to a country that is now a source of significant investments around the world. For European economies looking for investment and more avenues of growth, it is the dawn of a new era of cooperation.

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