Operating in a Difficult PRC Market – Brief for Directors & Senior Management

The current revival of the anti-corruption campaign has cast a pall over China’s business environment. Risks are real – and worsening – yet the Chinese economy presents opportunities to foreign investors who can hold their nerve, and be prepared to adapt to the challenges.

A Cold Spell in the PRC Business Environment

The environment in China has grown somewhat frosty. A recent survey by the American Chamber of Commerce showed that 81% of members felt unwelcome in 2016, up from 77% in 2015. These findings came as the anti-corruption campaign revived.

Future Direction – What’s Next?

The target is now clearly the financial sector, hitherto a cash cow for the Chinese elite. This anti-graft effort started with a crackdown on securities after the August 2015 stock market slide, but picked up with rhetorical and regulatory attacks on the insurance sector in late 2016, and led in April 2017 to the removal of China Insurance Regulatory Commission (“CIRC”) head, Xiang Junbo. Other heads may roll soon.

The campaign’s revival has demonstrated how anti-corruption purges have become the “new normal”. Chinese Communist Party (“CCP”) General Secretary Xi Jinping’s signature policy has become institutionalised, with the installation of personnel from the Central Commission for Discipline Inspection (“CCDI”), China’s anti-corruption watchdog, across the bureaucracy, and with the creation of a National Supervisory Commission.

Actions Ahead of the CCP Congress

The anti-corruption campaign is also a means to purge opponents ahead of the 19th CCP Congress, due this autumn. Targeting the finance sector has placed the “red princelings” on notice as to the need for their loyalty, and, given the huge stakes involved, some members of this elite are pushing back.

Guo Wengui, a tycoon who fled China in 2015, recently made lurid claims, concerning the HNA Group, the holding vehicle for Hainan Airlines and senior party leaders. Xi’s power means that his – and any other – pushback is most unlikely to succeed, but instead will only provoke further investigations, and corporate casualties.

Stasis as a Consequence of the Campaign

The anti-corruption campaign’s revival creates further uncertainties. The anti-graft ethos has already scared many officials into inaction, and the upcoming Congress only adds to an unwillingness to make decisions. As a result, government officials are not tackling key economic challenges, such as rising debt levels, weak regulatory standards, and a slowing economy that is too reliant on investment.

In the background is an ever strengthening trend toward economic nationalism. The CCP’s focus on nurturing national champions, through programmes such as the Made in China 2025 initiative, has intensified, and the regulatory apparatus has honed in on those sectors in which western companies have a strong position, such as automobiles, pharmaceuticals, and semi-conductors.

China’s 1950s-style mass line campaigns have re-instilled an atmosphere of a China under siege. The government has introduced laws on national security that will crimp foreign businesses’ activities, and the Beijing City government in March 2016 announced cash rewards for people denouncing foreign spies.

Opportunities Despite the Politics

Notwithstanding these threats, China still presents opportunities. The structure of the economy has changed, and to the better. The private sector long ago supplanted state owned enterprises (“SOEs”) as the engine of job creation, notwithstanding government support for the SOEs, while the mainstay export industry, especially for companies in higher end manufacturing, has retained some strength.

The consumer sector is growing rapidly, with opportunities in sectors such as automobiles, electronic commerce, software, and technology – for both local and foreign companies.

The ageing of China’s population is adding to demand for healthcare, notwithstanding the macroeconomic challenges regarding pensions, and Xi Jinping’s emphasis on urbanisation will boost industries such as transport and logistics.

How to React?

The challenge for foreign business, then, is to work around the risks. Companies can survive, and even thrive, in this less business-friendly China – provided that they act to understand and pre-empt threats, and are realistic about the new environment.

What can be practically done to Mitigate Risk?

In general, companies need to carry out a real world and independent audit of their vulnerabilities, such as their business partners who, in the changing environment may become liabilities amidst the anti-corruption campaign. Thereafter, they should prepare contingency plans to deal with threats.

Regulatory risk is also surmountable given reliable and timely business intelligence. Businesses, especially those in the finance and insurance sectors, should ensure that global oversight of the local business is strong, and not dependent on the opinion of local employees or regional chiefs whose compensation is dependent upon the continuing of questionable long standing practices.

Finally, investors must reappraise long-held assumptions. The liberalisation of the Chinese economy will probably slow further, or even halt, meaning that investments may not fuel growth elsewhere as, much as was hoped.

Businesses should pick over strategic plans, and conduct more intensive business intelligence studies, so as to improve the understanding of the possible vulnerabilities of their investments.

Be prepared

As stated, none of these threats are insurmountable, but they do make operating in China much harder. Any failure to pre-empt these issues, though, could seriously damage a company’s China business or global reputation.

What Can SVA Do to Assist?

SVA is in a strong position to help investors understand the nature of the risks in doing business in China, and in Asia as a whole. Please do not hesitate to contact us at the numbers below or via e mail to [email protected]

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SVA (www.stevevickersassociates.com) is a specialist risk mitigation, corporate intelligence and risk consulting company. The firm serves financial institutions, private equity funds, corporations, high net-worth individuals and insurance companies and underwriters around the world.