No free-for-all

It now seems pretty clear China will not be spared the ravages of the global economic downturn. While the country is still officially hoping to maintain a growth rate of at least eight percent this year, many independent experts are considerably less bullish. Predicting a “hard landing” for China, Fitch Ratings recently forecast growth slowing to six percent or less – which would mean the country's slowest rate of growth since 1990.

Amid these challenging new circumstances, what are the prospects for private equity investment in China? Let's consider the good news first. According to market sources canvassed by PEI, expect individual transactions to be waved through quicker by previously intransigent bureaucrats. The reason for this is the government's fear of social unrest as times get tougher – which lies behind instructions to local authorities not to allow unemployment to rise above a certain level within their jurisdictions.

“As local authorities try to stabilise local economies and employment, they are probably more motivated than ever before to be cooperative and efficient when they review and approve investments or transactions.” says Maurice Hoo, a Hong Kong-based partner in the private equity group at law firm Paul Hastings.

Sources also think asset appraisal laws may be reviewed. Nominally, the acquisition of assets in China has to be at “fair value”. But how is this fair value determined? “Typically,” says one market source, “the process has appeared geared towards arriving at a number that government officials are prepared to accept.” The source predicts the implementation of new laws that “will give people the ability to value assets the way they are valued in Western markets – in other words, true marking to market”.

Now for the bad news. Few expect any loosening of the restrictions on foreign investment in strategic industries. Essentially, this underlines the difference between short-term pragmatism and long-term policy. The Chinese economy may be less than healthy for the next 12 months, but a recovery is expected thereafter. Selling the family silver in the meantime is not seen as desirable or necessary.

Furthermore, foreign firms hoping to be able to set up Western-style limited partnerships are likely to be disappointed. While Chinese GPs were allowed to set up partnerships under new laws introduced in 2007, equivalent laws for foreign partnerships that were drafted at around the same time have still not been enacted – nor are they expected to be any time soon.

Sources say discussions of partnership law give rise to ideological conflict within the corridors of power in Beijing. Those in favour say foreign investors should be granted freedom to go about their business without constant regulatory intervention, while those against believe that close supervision is a good thing per se. A third group believes that foreign partnerships should not be waved through until local funds have first had the opportunity to evolve to the point where China has a domestic private equity market sufficiently robust to compete effectively with foreign funds.

Should the economy decline faster than anticipated, however, there is some speculation that panic might set in among companies desperate for capital. In this event, it may be that foreign partnerships come into being sooner than anticipated as a matter of expediency in order to funnel capital into the system as quickly as possible.

“Should the economy decline faster than anticipated, however, there is some speculation that panic might set in among companies desperate for capital.”

But no matter how far the economy falls, many believe that China can resolve its own problems without resorting to foreign assistance. Not least, this is because the country's fiscal reserves are now being directed internally rather than at overseas investment opportunities. This was underlined by a recent public consultation paper from the Ministry of Commerce, which would effectively revoke the same body's 2004 legislation designed to encourage investments outside the country.

Says one source: “The view is 'we've lost money [on overseas investments], now let's conserve it'. The rest of the world was waiting for China to rescue it from the financial crisis. That was never going to happen.”

What will happen instead – and is happening – is a massive programme of expenditure designed to boost domestic consumption and keep individual businesses and entire industries ticking over through the down cycle. It's an ambitious project, but China can afford to be ambitious – with or without the assistance of foreign capital.