Chinese companies can capitalize on new multinational investments

As the effect of the global financial crisis spreads, foreign direct investment (FDI) worldwide turned sluggish. The world's two largest emerging economies, China and Russia, saw a slowdown or even some decline in FDI inflows.

The decline of FDI inflow into China can be attributed to three factors.

First, tight credit caused by the global crisis has slowed down overall investment activity worldwide.

Second, part of the profits or cash reserves generated by multinational corporations in China has been redirected to support troubled parent companies, instead of being reinvested in the country.

Third, the appreciation of Chinese currency, the yuan, has slowed down since the start of the crisis, which, as a result, has removed one of the key incentives of FDI by multinational corporations in China.

The decline of FDI inflow into Russia can be largely attributed to the sharp decrease of commodity prices and personal wealth.

Although both China and Russia are experiencing a decline in FDI inflows, it does not mean that all multinational corporations are reducing investment in these two large emerging markets. Indeed, some of these corporations are actually increasing their investments to capture the opportunities created by the global financial crisis and the responses of the Chinese and Russian governments.

Although China absorbed a record $92.4 billion in FDI inflow in 2008, the growth rate of monthly FDI inflow (on a year-to-year basis) actually turned negative in the fourth quarter of the year. This trend continued in 2009.

Until June 2009, FDI inflow to China experienced negative growth for nine consecutive months. China absorbed only $43 billion in FDI during the first half of 2009, representing a 17 percent decrease from the first half of 2008.

Policy changes

In response to the global financial crisis, the Chinese government unveiled a $586 billion stimulus package on Nov 9, 2008, to revitalize the country's slowing economy.

The money will be spent over the next two years to finance programs in 10 major areas such as low-income housing, rural infrastructure, water, electricity, transportation, environmental protection, technological innovation and rebuilding from several natural disasters.

The Chinese government has also adjusted policies to attract foreign investment. For example, the central government relaxed and decentralized the regulations on foreign investment in recent months.

Local governments are now authorized to approve foreign investment projects worth up to $100 million without seeking ministry-level approval.

This relaxation and decentralization in authority applies to business startups, acquisitions of domestic firms and the expansion of existing operations of foreign-owned companies.

In addition, the government has lowered the export quota for foreign-invested enterprises (FIEs) so that FIEs can supply the domestic markets rather than meet the export quota of their outputs.

Another change in government policies is to make the central and western regions more attractive to foreign investors.

To attract foreign investment, local governments in the central and western areas have come up with various preferential measures such as tax breaks, low-interest loans and cheap rent on industrial-purpose land.

Foreign investors are encouraged to invest in agriculture, environmental protection, infrastructure and industrial upgrades.

With tax breaks, they can also invest in occupational training, the operation of holiday destinations and even passenger transportation by bus or train. Foreign investors can start businesses either on their own or via joint ventures with Chinese partners.

FDI reactions

Due to the global financial crisis, many multinational corporations are suffering from sharp contractions in demand, causing serious challenges for them

However, many multinational corporations are responding favorably to China's relatively fast economic growth, increasing per capita income and domestic consumption, massive government stimulus package and well-controlled inflation.

According to a survey by the US-China Business Council, 88 percent of foreign businesses in China are profitable, and 81 percent have a higher profit margin than elsewhere.

Many foreign companies see new opportunities amid the global financial crisis to invest in China. They are taking advantage of the recent changes in government policies to adjust their strategies and to strengthen their positions in the country.

One reaction by multinational corporations is to accelerate localization in response to the lowered export quota for foreign-owned companies.

For example, Cisco announced a $16 billion investment plan in China amid the crisis by emphasizing its strategy to be more localized in China, shifting from "Cisco in China" to "China's Cisco".

Bosch Group also announced that it plans to invest another 850 million euros between 2008 and 2010, in addition to the 1 billion euros the company already invested in China in the years up to 2007.

"We see ourselves as a true partner for China's dynamic economic development. More than ever before, Bosch is also a Chinese company," said Franz Fehrenbach, chairman of the board of management of Bosch Group.

Bosch has established a solid basis to further increase its presence in China. By the beginning of 2009, the number of Bosch associates in the country was about 23,000, greater than in any other country outside its home country, Germany. Its research and development (R&D) activities in China embrace all its business sectors.

R&D investments

Thanks to the ongoing investments by multinational corporations and the increasing need to be closer to local customers, there are now approximately 1,000 R&D centers in China. Most are in the technology sector.

Another reaction is to take advantage of the stimulus package to increase investments in energy and environmental protection, especially regarding clean and renewable energies.

Several large foreign-owned corporations, including Siemens, ABB Ltd, Bosch Group and Alstom, have decided to increase their investments in this area.

These multinational corporations react to not only the immediate impact of the stimulus package, but also strong business growth in the past and the long-term potential of the Chinese market in the future.

The global financial crisis makes the importance of the Chinese market even more prominent in some industries. One of them is the automobile industry.

In contrast to the significant drop in the United States, Europe, and Japan, car sales in China remained strong. China sold 4.5 million passenger cars in the first six months of 2009, representing a 25.6 percent increase from a year ago, as the government's tax reduction and incentive subsidy for rural residents spurred small car sales.

In fact, China is now the world's biggest auto market in terms of the units of vehicles sold. Foreign carmakers are rushing to either raise vehicle output or open new plants in China, based on a strong economic recovery in the first half of 2009.

Financial services

Another area is the broad financial services sector.

China in 2008 approved foreign investment in 23 financial services companies, including banks, non-banking financial service institutes, security companies and insurance companies.

The financial services sector absorbed foreign investment totaling $15.92 billion, representing an increase of 81.85 percent. Foreign financial companies continue to show great interest in investing in China.

Foreign financial service companies do not only increase investment in the financial services sector. They also are increasing their investments in local non-financial companies with strong market conditions or potential.

Given that China is the world's fastest-growing major economy, some foreign-owned companies even plan to use investments in China as a major step to overtake their rivals as industry leaders.

For example, Germany's Metro AG, the world's fourth-largest retailer in sales, believes that with an aggressive plan to expand in China, it can overtake US giant Best Buy Co as the world's biggest consumer electronics retailer.

With a local joint-venture partner, the German retailer plans to open a Media Market store in Shanghai next year, rapidly followed by at least another 12 and eventually about 300 more in large metropolitan areas.

Metro's strategy shows how fiercely global retailers are competing in lucrative international markets, as growth in their already mature home countries slows with the downturn.

Impact on local firms

Activities by foreign-owned corporations in China have important implications for local firms.

First, the acceleration of localization and increasing focus on the Chinese market will surely increase the level of competition faced by local firms.

The competition does not only come directly from multinational corporations that are in the process of localization such as Cisco and Bosch, but also local Chinese firms that receive foreign investments for expansion such as Red Lion Cement and Gome.

Moreover, the competition is not limited to the product market, but the input market as well, particularly regarding local talents. For example, as more and more foreign-owned companies establish R&D centers in China, local Chinese firms have to compete with these multinational corporations for top researchers.

Second, some Chinese firms, especially those with high potential for growth, might increasingly become targets of acquisition, considering the increasing importance of the Chinese market, relaxed government regulations about M&As by foreign firms and the intention of multinational corporations to increase their market share and become industry leaders.

However, the Chinese government has raised concerns about potential market monopolies as more M&As have consolidated industrial structures in recent years.

The implementation of a new anti-monopoly law has, therefore, imposed constraints on aggressive M&A activity.

The failed proposal of Coca-Cola to acquire China's largest juice maker, Huiyuan Juice Group, for $2.3 billion perhaps indicates the government's concerns about monopolies in a single industry.

Therefore, we predict that secondary local Chinese firms, not industry leaders, are more likely to become acquisition targets of foreign firms.

Third, the acceleration of localization by multinational corporations can also create many opportunities for local Chinese firms, particularly those in supporting industries.

For example, to bolster its ambitious expansion plans in China, KFC recently placed an order worth $732 million with three Chinese chicken suppliers.

The expansion plans of foreign car makers surely will bring many opportunities to local suppliers, as well as sales and service providers.

Even for those local firms that directly compete with multinational corporations, there are increasing opportunities for them to cooperate and/or to learn from their foreign competitors.

This is a monthly report by the Moscow School of Management SKOLKOVO Institute for Emerging Market Studies, a think tank that specializes in the economy and business in emerging markets. The views are those of the institute.

(China Daily 11/02/2009 page2)