When Chinese deals turn sour

When Chinese deals turn sour
By Clare Nuttall in Glasgow September 12, 2019

The Central, Eastern and Southeast Europe regions have been targeted by Chinese investors along with other parts of the European continent and other world regions as Beijing rolls ahead with its multi-continental Belt and Road Initiative (BRI). 

This has brought billions of euros into the region especially in areas such as energy and transport infrastructure, often where countries have struggled to get financing from other sources. Increasingly, Chinese investors have also snapped up industrial and commercial assets. 

However, as investment rationales often differ from pure market interest, and business cultures clash, some of the many deals in the region have flopped. 

report published by Rhodium Group (RHG) and the Mercator Institute for China Studies (MERICS) earlier this year found that Chinese investment in eastern EU member states only accounted for a tiny share (1.5%) of Chinese investment in the EU, and the volume of investment declined in 2018, as did investment across the EU as a whole, by a startling 40%. 

In addition, says the RHG/MERICS report, “in 2018, for the first time, Chinese investors sold European assets on a significant scale. We estimate that Chinese firms divested at least €4bn worth of assets in the EU”.

There are a variety of reasons for the abrupt slowdown in Chinese investment in Europe, and indeed the downward trend in China’s global outbound FDI, which RHG/MERICS attributes to “continued capital controls and tightening of liquidity in China as well as growing regulatory scrutiny in host economies”.

Caught in the crossfire

As the trade war between Washington and Beijing escalates, countries around the world are getting caught up in the standoff. In one of the latest such incidents, a diplomatic spat has broken out in Ukraine over Chinese plans to buy a controlling stake in Motor Sich, the world’s largest producer of aeroplane and helicopter engines. 

If the deal gets the go-ahead from Ukraine’s Antimonopoly Committee, Chinese firms Skyrizon Aircraft and Xinwei Technology Group will control more than 50% of Motor Sich, according to reports in the Ukrainian media. As part of the deal, the Chinese firms will grant $100mn to Ukraine’s aviation industry. 

This worried US officials, with US President Donald Trump’s recently sacked national security advisor John Bolton warning — not long before his dismissal on September 10 — that the US administration will prevent Ukraine from cooperating with China and offering military technologies. "Ukraine will make its decision but perhaps, Ukraine will find a better choice that will have better economic consequences for its citizens," Bolton said during a visit to Kyiv. "Military and sensitive technologies should not end up with adversaries or potential adversaries."

In response, China urged the US not to interfere in the “internal and external affairs" of Ukraine, Beijing’s ambassador to Ukraine Du Wei said on August 30. 

From a broader perspective, global politics are also likely to determine the impact of the BRI over the next decade. A newly released report from BRI consultancy Silk Road Associates, compiled in partnership with global law firm Baker McKenzie, says that the 2020s could be a "golden era for emerging market infrastructure investment" — but only if "leading economies can find ways to overcome geopolitical concerns to fund projects multilaterally, and private global capital can align with China's Belt & Road Initiative in an ongoing and sustainable way."

This is the most optimistic of the five scenarios laid out in the BRI & Beyond Forecast published on September 11. The scenario sees investments of up to $1.32 trillion over the 2020s. By contrast, the worst-case "Uni-Polar Model", which "sees the impacts of a significant recession coupled with increasing nationalism and more aggressive competition from other nations, values potential BRI-related investments in the 2020s at only $560bn."

A controversial investor

But the pressure isn’t always external. There has been an upturn in anti-Chinese sentiment in the Central Asian countries that border the East Asian giant, as while the billions of dollars poured into their transport and energy infrastructures are welcomed by politicians, some citizens fear a colonisation by stealth from Chinese investment in their most important physical assets, not to mention debt burdens mounting up for future generations. 

A 2018 report from the Washington-based think tank the Center for Global Development found that in three Central Asian economies, namely Kyrgyzstan, Mongolia and Tajikistan, future BRI-related financing will “significantly add to the risk of debt distress”, and it warns of similar risks in the small Balkan economy of Montenegro. 

In Kazakhstan, protests have been ongoing for days in the remote oil town of Zhanaozen against aspects of Kazakhstan’s growing investment reliance on Beijing, and have taken place (though in smaller numbers) in larger Kazakhstani cities including the capital Nur-Sultan. Zhanaozen has a reputation as a flashpoint for unrest in Kazakhstan; following months of strike action, the authorities shot 16 rioters dead in December 2011. 

The protesters are urging the Kazakh government to cease accepting loans from China. They are also challenging the official plan to construct 55 industrial facilities with Chinese assistance, and tried unsuccessfully to pressure President Kassym-Zhomart Tokayev to scrap his visit to China that started on September 11.

Although the demands of the protesters are unlikely to be met, the rallies reflect wider anti-China sentiments. These sentiments have been exacerbated by constant news of China’s so-called “re-education camps”, which are said to hold thousands of ethnic-Kazakh citizens of China in Xinjiang.

There have been similar events in Kyrgyzstan recently. Chinese company Zhong Ji Mining has suspended its operations at Solton-Sary gold mine in the east of Kyrgyzstan following a mass brawl between local residents and company workers in August.

A high-profile failure 

Far from the border with China, the countries of Central and Southeast Europe have been wary about accepting investment and soft loans from Beijing, despite participating enthusiastically in the annual 16+1 forum that typically results in announcements of billions of euros of funding and deals — though there is some scepticism about how many of these result in concrete investments and how long the process takes. 

Chinese investment in the region started with infrastructure projects, with early examples such as the Zemun-Borca Bridge, otherwise known as the “China-Serbia Friendship Bridge”, in Belgrade. This helped put to work the excess capacity of China’s huge engineering companies as economic growth within China started to slow. But Chinese investors have since branched out into other sectors, starting with the snapping up of cheap industrial assets in the wake of the international financial crisis. 

This trend has continued; the RHG/MERICS report finds that in 2018, “Chinese capital was spread more evenly across sectors compared to 2016 and 2017. Investment declined in transport, utilities and infrastructure, and real estate. The biggest increases were recorded in financial services, health and biotech, consumer products and services, and automotive.”

One of the players that emerged in this increasingly diverse wave of investment was a conglomerate named CEFC China Energy that embarked on an acquisition spree across Central and Eastern Europe. It targeted not only energy assets, such as Romania’s Rompetrol Rafinare and Russia’s largest oil company Rosneft, but also a raft of assets in the Czech Republic and Slovakia in particular, including Czech top-tier football club Slavia Prague, hotels and office buildings.

But before several of its announced deals had time to close, rumours of serious financial problems at CEFC surfaced, and the company defaulted on its bond payments. Then it was reported that the chairman of CEFC, Ye Jianming, was being investigated in China for alleged economic crimes. 

The deals to acquire stakes in both Rosneft and Rompetrol Rafinare’s owner, Kazakhstan’s KazMunayGas International (KMGI), fell through, while in Czechia the local regulator officially approved a takeover of CEFC by Chinese state-owned investment company CITIC in June 2018. 

The debacle had political consequences in the Czech Republic, where CEFC’s connections to top politicians had previously raised concerns. Its investment drive was promoted by President Milos Zeman and his inner circle, who were keen to deal with Beijing. Zeman has been a regular visitor to the Chinese capital.

The implosion of CEFC Europe raised concerns over how stable and beneficial Chinese investments were and to what extent they were a political tool to increase Chinese influence in the Czech Republic. 

More recently, fears that tech giant Huawei was being used by the Chinese government to spy on its customers added to the impetus for a tightening of restrictions on Chinese investments into certain sensitive sectors. Several EU countries have already introduced tighter screening for foreign direct investments, which RHG/MERICS’ report links to the slowdown in Chinese investment in the 28-member bloc. 

There are also concerns in some countries about Chinese investments in critical infrastructure. Estonia, for example, has demanded more details on the financing of the planned Helsinki-Tallinn undersea rail tunnel linking its capital to Finland prior to giving the green light for the €15bn project, as reported by local media in August. A few months earlier the project’s developer FinEst Bay Area Development had signed a memorandum of understanding with China’s Touchstone Capital Partners, which is providing €15bn funding for the project. 

Litex’s breakdown

Alongside CEFC’s dramatic collapse, several smaller deals also involving Chinese investors in the Central and Southeast Europe regions have turned sour. 

Bulgarian carmaker Litex Motors went bankrupt in 2017 after announcing it would assemble cars from China’s Great Wall brand and sell them both in Bulgaria and the rest of Europe. The Chinese investors were working with controversial Bulgarian businessman Grisha Ganchev, with the support of Corporate Commercial Bank that collapsed in 2014.

An analysis from Bulgarian National Radio (BNR) commented that “Besides partnering up with dubious characters, Great Wall doesn’t seem to be very good at doing the math either.” It cited the heavy cost of transporting vehicle parts and aggregates from China to Bulgaria, as well as the small local market. Bulgaria, as the EU’s poorest country, is dominated by second-hand cars.

Failing to take off

Meanwhile, the aviation sector appears to be particularly plagued by failed investments. 

China’s SHS Aviation signed a 15-year lease agreement for Aerodrom Maribor in Slovenia’s second city in 2017, promising to turn Maribor into a hub for Chinese tourists. This never happened. Instead, SHS announced it was giving six months’ notice to terminate the agreement due to delays in expanding the airport’s runway. It argued that the concession agreement was “unsustainable”. The airport has been temporarily placed in the hands of Slovenian state-owned consulting company DRI. 

There was also Chinese interest in taking over the management of Plovdiv airport in Bulgaria. A consortium led by the Chinese group HNA won the 35-year concession contract for the airport, but decided against signing the contract.

The Chinese investor apparently lost interest in the deal after the sudden death of the president of the corporation Wang Jian, in an accident in France. Separately, the group has accumulated huge debts over the past years and cut its investment programme around the world.

However, the airport could get an alternative Chinese investor, given that the government has repeatedly extended the tender period. One of those interested is the UK’s Manchester Airports Group (MAG). It has said that it intends to bid for the concession in partnership with Chinese state-owned Beijing Construction Engineering Group (BCEG). 

Also in the aviation sector, Czech media reported in June that the biggest Czech airline, Smartwings, is facing a serious crisis, after its Chinese co-owner disallowed an increase of capital stock for the second time. 

The company wanted to compensate for the losses caused by issues with Boeing 737 MAX aircraft, which made up one-third of Smartwings’ fleet, by increasing its capital by CZK700mn (€27mn) or even by CZK1.4bn, according to information obtained by portal Zdopravy.cz in May. The planned increase was supposed to be made by two of the biggest stakeholders, Unimex Group and China International Group Corporation Limited, but the latter has so far not agreed to the hike.

“It is a serious situation for sure. Reluctance of the Chinese stakeholder signals it has a little faith in the company. Once you reject an increase of capital stock, you must count on the company’s end,” said J&T Bank chief analyst Milan Vanicek in a comment at the time.

“It remains unclear why the Chinese stakeholder rejects an increase, as there is an objective reason for it, which wasn’t caused by the carrier. Either the Chinese don’t have funds for such an increase or they don’t want to do it. So, why did they buy the company in the first place?” Vanicek added.

Different values 

In the Western Balkans, Chinese banks have become an important source of finance for coal-fired power plants in particular, as other partners such as the EU and multilateral development banks are increasingly unwilling to finance fossil fuel projects. This has raised concerns about the ability of the region — which contains some of Europe’s most polluting power plants already — to meet EU emissions standards as countries aim for accession to the bloc. 

This conflict came out into the open over plans to expand Bosnia’s Tuzla thermal power plant, a project worth BAM1.5bn (€870mn) that will be mainly financed under a €614mn state-guaranteed loan provided by China ExIm Bank. The contractor for the works is China Gezhouba Group.

The project prompted criticism earlier this year from the European Commission both because it entails burning coal and because it is financed by a Chinese bank. Enlargement Commissioner Johannes Hahn criticised Bosnia’s decision to extend a sovereign guarantee, warning that the EU will monitor such issues closely when deciding whether to grant the country candidate status.

“Issues like environmental impact assessments, state aid + public procurement procedures will certainly be closely looked at during the opinion process,” Hahn tweeted. 

The Bosnian Federation's Prime Minister Fadil Novalic, however, said the entity had no alternative because it risks power shortages by 2027. 

Changing policy in a changing world 

The former socialist countries are by no means the only world region targeted by Chinese investors. Aside from developed regions such as Western Europe, Beijing has also been highly active in Africa, again focusing on major infrastructure projects. China has emerged as the single largest financier of African infrastructure, financing one in five projects and constructing one in three, according to a Deloitte study. In September 2018 President Xi Jinping announced a further $60bn funding package for Africa.

But here again there has been controversy. The Deloitte study says, “While China’s infrastructure investments on the continent have assisted a number of African states to overcome their dependency on conditional foreign assistance and follow a non-interference clause, a frequent criticism is that such projects have produced little real benefit for local economies while increasing their debt burden.”

A report from the Financial Times poured doubt on the benefits of Chinese investments in two high-profile and expensive rail projects in east Africa. The economic viability of the lines, one from Djibouti to Ethiopia, the other across Kenya from the port of Mombasa to the capital Nairobik, is in question.

The report quoted Xi as saying in September 2018 that “vanity projects” must be shunned in favour of more carefully conceived initiatives that address proven economic bottlenecks.

The RHD/MERICS study doesn’t consider the declines in Chinese outward FDI in 2017 and 2018 to be a blip, but rather a “new chapter” in the pattern of investment. The turn of the page was driven largely by the policy line from Beijing. 

And while there are reasons for the investment fall-off that can be seen in the destination countries — political backlashes against Chinese investment, investment motives that don’t line up with market reality — according to RHG and MERICS, “The main reasons for this continued slump are still to be found at home: In 2018, Beijing maintained its tight grip on outbound capital flows; it pressured highly leveraged firms to sell off overseas assets; and it reduced liquidity in the financial system amidst a broader clean-up of the financial sector, thus drying out financing channels for overseas investments.”