The war in Ukraine has created fresh geopolitical risks that companies In China must grapple with. The hard news is that China has adopted a stance of ‘pro-Russia neutrality’. The good news is that China’s economic ties with the West are too strong for it to risk business going down the same path. At a recent IMA China CEO Forum meeting, a Forum member counselled that,
‘It is important when speaking with headquarters to be mindful that there is a difference between China’s rhetoric versus its actions towards sanctions. China has been consistent in its public rejection of sanctions on principle. But if you look at Chinese banking institutions, they have been careful to adhere to the sanctions.’
Still, MNCs operating in China face potential risks to their businesses as the war drags on. Over a series of sessions of the China CEO Forum, firms discussed the potential impact of the Ukraine War on their business.
Chinese firms are wary of circumventing sanctions
The Chinese government has taken a position of neutrality concerning the war, a balancing act that many are tracking carefully. A position of political neutrality is much tougher for Chinese businesses to follow. Even so, there may be a pragmatic reason why Chinese firms have not gone on a sanctions-busting spree: Russian customers no longer can pay in US dollars.
‘Most POEs in China use Hong Kong as an invoicing centre. They export to Hong Kong and then re-export to the world, enabling them to accumulate US dollars in Hong Kong. Now, they can no longer do transactions with Russia in US dollars. Instead, they will have to rely on a mechanism created by the Chinese banking system for RMB payment to Russia, and that system is not yet in place.’
A rouble-to-yuan payment system bypassing the US dollar alone will not solve Russia’s problems. Since the war, Russia has become an even riskier place. China’s behaviour could mean that not everybody is lining up to export to such a risky market.
‘Before the war, Chinese private firms viewed Russia as an unattractive, low-margin market. Russia has a complicated legal system and complex logistics, and its customers are known for being poor payers.’
Hedging your China bet
Many China CEOs expect that geopolitical tensions are unlikely to calm down anytime soon. The only choice is to jump into the China market and deal with the difficulties as they arise. An investment advisor commented at an IMA Forum meeting,
‘We have 30 medium-to-large size firms all looking to do M&A projects in China. None of them has changed their mind about their China growth trajectory. We have one client who postponed an investment because of the US-China trade war; they regret it now because they lost a year. Taking a wait-and-see approach does not work anymore.’
Nevertheless, being in the China market does not mean throwing caution to the wind. On the contrary, firms should ‘hope for the best, but prepare for the worst’. Hedging your bets can reduce the harm that could arise if the market is sanctioned. Staying agile with an asset-light strategy is one way to do so. A ‘China for China’ approach where the business sustains itself is another.
‘Despite the war, many firms will continue to invest heavily in China because it is the source of 20% to 40% of their profits. They will use dividends, bonds, loans, and more creative investing methods to fund their investments. An asset-light model of investment in China is a more cautious approach that some are taking, so is a model where cash flows generated in China are sufficient to reinvest in China.’
Balance the balance sheet
Firms have little control over dire geopolitical forces, but they can control their balance sheets.
‘Clearly, a catastrophic event in China would negatively affect the global P&L. But global corporations with many assets in China still can protect their balance sheet. This is because assets in China have been denominated in renminbi (RMB), but these investments are based on US dollar- or Euro-based funding.’
CEOs usually focus on the business case and the P&L for an investment, while leaving their treasury department to handle how it appears on the balance sheet. However, now is a good time for CEOs to leverage liabilities as a strategic hedge.
‘Increasingly, firms are ensuring that liability and assets denominated in RMB match on the corporate balance sheet. This creates a natural hedge against foreign exchange movements and ensures that a catastrophic event related to an asset also equally hits a liability. Treasurers must find ways to match the two sides more evenly.’
IMA Asia members can download and read the full paper on ‘War in Ukraine: Insulating the China Business’ by clicking on ‘Deep Read’ and downloading the paper. To learn more about IMA Asia’s memberships or subscribe to our ‘Asia Forum Notes’ or ‘China Forum Notes’, contact us at email@example.com.