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Earlier this week the controlling shareholder of HNA pledged over 50 per cent of its stake as security for a loan. Photo: AFP

Chinese firms that ‘went global’ at Beijing’s request now hit hard by capital controls

Bob Li, owner of an export-oriented leather bag maker in Jiaxing, Zhejiang province, feels that his “outbound” strategy has become a bitter pill to swallow after China’s crackdown on cash outflows dealt a heavy blow to the company’s overseas business plans.

Li’s business, Jiaxing Boya Leather Bag, was among the thousands of mainland firms that followed Beijing’s exhortations in the past few years to “go global” – but now they are getting hard hit by the central government’s exchange controls.

The dismal state of the domestic mainland economy and rising business costs prompted Li to make a bold decision in 2014 to relocate his production line to Southeast Asia where land and labour costs are lower.

“I still have clients in Europe. I believed a Vietnam-based plant could be profitable based on the existing orders from these European clients,” he said. “More importantly, this outbound move was in line with the Chinese government’s direction to go global.”

However, his expansion plans have been hit by the recent capital controls implemented by Beijing. When Li tried to secure an overseas loan with domestic guarantee to fund the newly established subsidiary in Vietnam, the bank rejected his application citing tightened exchange controls by the country’s foreign-exchange regulator.

“It’s the problem of the capital crunch,” he said. “I shouldn’t have made the outbound plan.”

Companies that need to send money abroad to replenish overseas expansion are now forced to revisit their growth plans after falling victim to the central government’s new measures.

Beijing has yet to make yuan fully convertible under the capital account, with cross-border capital flows for investment subject to regulatory approvals. Alternatively, businesses must use special arrangements to enable the transfer of money out of the country.

Taking out an overseas loan with a domestic guarantee is a popular approach used by mainland companies wanting to fund their international expansion.

In a typical case, a Chinese firm with large yuan deposits at a local bank will use the money as a guarantee to apply for a foreign-currency loan granted by the bank’s overseas branch to the firm’s subsidiary outside the mainland.

This lending approach effectively helped companies go global over the past two years despite the lack of efficient oversight on how the money was used.

According to banking employees in charge of this type of lending, overseas loans with domestic guarantees grew quickly over the past three years, buoyed by a positive attitude from regulators who had hoped to encourage more capital outflows to ease excessive liquidity in the mainland economy.

Starting in August, Beijing introduced curbs to these lending practices in a bid to stem the outflows after the yuan began to weaken. The currency fell to an eight-year low against the US dollar in November, resulting in a drop in the mainland’s foreign reserves to about US$3 trillion last month from the record high of nearly US$4 trillion in 2014.

None of the applicants applying to transfer more than US$3 million cash abroad over the past two months have received approval, according to three banking officials, who requested anonymity.

The U-turn, following years of efforts to inspire mainland firms to go abroad, exacerbates the already bearish sentiment among Chinese entrepreneurs.

However, analysts say companies can still acquire or invest in overseas assets but they need to try different ways of getting capital out of the country.

Earlier this week, the controlling shareholder of HNA Holdings, an acquisitive Chinese aviation and shipping giant, pledged over 50 per cent of its equity stake as security for a loan.

HNA didn’t specify what the loan is for, but it could be a way of acquiring foreign currency for overseas deals without having to get Beijing’s approval, said Emma de Ronde, a Hong Kong-based partner with Norton Rose Fullbright.

“This is an interesting transaction as it would allow the Chinese shareholder to raise foreign currency, presumably for the purposes of reinvestment, but without having to liquidate its existing assets (being the shares in the Hong Kong-listed company, HNA),” she told the Post.

De Ronde, who has extensive cross-border M&A experience, said if funds are already offshore, the Chinese company doesn’t need approval to reinvest – although it would need to update certain regulatory filings.

But not all companies can take advantage of such a move as many controlling shareholders of Hong Kong-listed companies hold their shares on the mainland. If a Chinese-owned company wants to borrow money offshore, that borrowing needs prior approval by Beijing.

“Tightened control on money outflow could affect those who planned but have yet to complete the money transfers,” said Han Haifeng, chief executive of manufacturer Shanghai New Century Packaging.

“Those early birds have already completed their overseas investments or remitted the money outside the country. This policy is giving a clear ‘no’ to me that there’s no way I can make overseas investments.”

Christopher Chua, head of China M&A for Credit Suisse, said the mainland’s “robust” M&A activity of the past couple of yearswas likely to slow down next year following Beijing’s moves to tighten capital controls.

“I think they want to stop irrational deals,” Chua said. “That said, these moves stand to improve deal quality and promote a better outbound deal-making environment for genuine and strategically-motivated transactions.”

Additional reporting by Alun John

This article appeared in the South China Morning Post print edition as: Feeling the pinch
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