Quarterly Flash Note, May Data and website updated with information up to March 31 st 2012 Next database update in September 2012.

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1 Quarterly Flash Note, May 2012 Data and website updated with information up to March 31 st 2012 Next database update in September 2012 Key Changes In 2012Q1, China registered the lowest number of operations for inward direct investment since 2005 with only 313 operations. The amount invested in China was USD 8.9bn, far below the USD 15bn average quarterly amount observed since Hong Kong and the USA were the largest investors in China in 2012Q1, with respectively 36% and 28% of the total amount invested. The major difference compared to the overall structure of FDI in 2011 is the sharp decline in the share of EU27, with 10% of total amount in 2012Q1 compared to 25% in Despite the reversal in the overall real estate market and growing restrictions, the real estate and the auto & transport sectors attracted the largest amounts of FDI in China in 2012Q1 (in terms of total amount invested). Chinese strategy to invest abroad remained very active in 2012Q1 with total outward foreign investment (ODI) reaching USD 14.7bn across 149 different operations. Chinese investors continue to concentrate the majority of deals and operations in developed countries with EU27 remaining the top destination with 23% of deals in 2012Q1 (34 over 149 operations), followed by USA (17 operations) and Hong Kong (11 operations). Germany, France and UK remain the largest targets within the EU27. However, the largest amount invested were in Latin America (Brazil, Argentina) notably (again) in the energy and commodities & materials sectors which respectively represented 50% and 19% of the total amount invested in 2012Q1. China also increased its participation in the electronic/software/it sector with 51 operations over a total of 149 operations, including 13 operations in EU27. Page 1

2 Recent trends on FDI inflows into China The previous China Observatory reports (#14, December 2011 and Flash #1, February 2012) signalled uncertainties related to the FDI inflows rebound observed in 2011 compared to the previous year. According to our COFM database, FDI inflows into China remain below levels observed prior to the global financial crisis. Figures for 2012Q1 confirm the trend, with the lowest registered number of operations since 2005 (313 deals). The observed dynamic is quite similar to MOFCOM figures. Looking at historical observations over the same period, a limited number of quarters registered total operations below 400. This included the crisis outburst from 2009Q1 to 2010Q1 and the last two quarters. The amount of FDI invested into China in 2012Q1 increased by 21% year-on-year but reached only USD 8.9bn, far below the average quarterly amount observed since 2005 (around USD 15bn). Moreover, 75% of this amount is explained by a small number of large deals (16) originating from Hong Kong (6 deals), the USA (4 deals), Singapore (2 deals), Taiwan (1 deal), France (1deal), Russia (1 deal) and Norway (1 deal). Largest foreign investments into China (>USD 150mn) in 2012Q1 Date Type Ultimate parent (country) Target Sector Amount (USD mn) Feb, 12 GF CapitaLand China (Singapore) Real Estate 953 Mar, 12 M&A China Daye Non-Ferrous Metals (HK) Prosper Well Group Ltd Financial Services 940 Feb, 12 M&A Newco 123 Hong Kong Ltd (USA) Intl Mining Mach Hldg Ltd Equipment 854 Feb, 12 M&A Wandle Investment Ltd (USA) Little Sheep Group Ltd Retailing 570 Feb, 12 GF GreatPoint Energy (USA) Energy 420 Jan, 12 M&A Moscan Developments Ltd (HK) Widefaith Group Auto, Transport 402 Feb, 12 M&A Arkema SA (France) Suzhou HiPro Polymers Co Chemicals 365 Mar, 12 GF CS Aluminium (Taiwan) Commodities, Mat 339 Jan, 12 M&A ChinaVision Media Group Ltd (HK) China Entertainment Media Elec, Software, IT 301 Mar, 12 M&A Morgan Stanley Private Eq Asia (USA) Tianhe Chemicals Group Co Energy 300 Jan, 12 M&A Moscan Developments Ltd (HK) Chinese Future Corp Auto, Transport 280 Feb, 12 M&A Grand Supreme Ltd (HK) Grandbiz Holdings Ltd Real Estate 272 Feb, 12 GF Rostvertol (Russia) Aerospace 224 Feb, 12 M&A Investor Group (Singapore) Trendy International Group Commodities, Mat. 200 Jan, 12 GF Odfjell Terminals Asia Commodities, Mat. 160 Jan, 12 M&A DB Trustees (HK) Ltd Shenyang Investment (BVI) Tourism 155 Overall, Hong Kong and the USA invested more than half of the 2012Q1 total, accounting for 36% and 28% respectively. Singapore also appears near the top of the list with 14% of total FDI inflows. The major difference from 2011 is the declining share of EU27 investment into China, representing only 10% in 2012Q1 compared to 25% during the previous year, undoubtedly explained in part by the Europe s debt crisis. The second change in 2012Q1 concerns the sectors of interest. While the commodities & materials, the chemicals, the electronics & IT and the auto & transport were the main sectors in 2011, real estate and auto & transport received the most attention in 2012Q1 in spite of growing restrictions in these sectors. Page 2

3 Recent trends on FDI outflows from China The picture on outflows from China is different with ODI more than tripling over the past few years from USD15.6bn in 2005 to USD5.62bn in The surge is clearly noticeable at the end of the global financial crisis, i.e. from 2009Q4, highlighting the presence of new investment opportunities abroad for China. Since then, Chinese investors have made, on average per quarter, 145 operations representing USD 14.1 bn each quarter. Figures for 2012Q1 are very close to this recent average (149 deals for USD14.7bn). The breakdown by sector is similar in 2012Q1 is similar to 2011 with 70% of the amount invested concentrating in the energy (50%) and the commodities & materials (19%) sectors in an attempt to secure strong domestic demand. They were followed by the equipment (11%) and the food & beverages sectors (8%). Indeed, Chinese investors continue to massively invest in these sectors with 6 big deals (>USD1bn) equalling 80% of the total amount invested. In addition, Latin America remains an attractive area for China (in the energy and food sectors), particularly in Brazil and Argentina. Largest Chinese investments abroad (>USD1bn) in 2012Q1 Date Type Ultimate parent (country) Target Sector Amount (USD mn) Mar, 12 M&A Sinopec Intl Petrogal (Brazil) Energy 4800 Feb, 12 GF Beijing DQY Agriculture Technology (USA) Energy 1800 Feb, 12 M&A Investor Group Lasalle Invest Mgmt (Japan) Equipment 1572 Feb, 12 M&A MMG Malachite Ltd Anvil Mining NL (Australia) Commodities, Mat Feb, 12 GF Chongqing Grain Group (Argentina) Food and Beverages 1200 Feb, 12 M&A China Guangdong Nuclear Power Kalari Minerals PLC (UK) Commodities, Mat Page 3

4 However, Chinese investors continue to concentrate the majority of their operations in developed countries. The EU27 remained the favourite destination for China, drawing 23% of the volume invested (34 over 149 operations), followed by the USA (17 operations), Hong Kong (11 operations), Australia (10 operations), Japan (7 operations) and Singapore (6 operations). Moreover, 34% of the volume invested by China abroad is in the electronic/software/it sector (51 over 149 operations), followed by the commodities & materials (21 operations), services (16 in financial services and 11 in other services) and the equipment sector (10 operations). FDI/ODI flows and EU Member States The EU27 FDI inflows into China have declined over the first quarter of 2012 with only around 900mn invested and 84 operations (compared to around 130 operations per quarter in 2011). FDI flows from China into the EU27 have also decreased in 2012Q1 compared to the previous year with only 34 operations recorded. Similar to previous years, Germany, the UK and France remained the most important destinations for China s investment in the EU27. EU27 FDI into China China ODI into EU q1 2011q2 2011q3 2011q4 2012q1 2011q1 2011q2 2011q3 2011q4 2012q1 Total Amount (USD bn) Greenfield M&A Number of Operations Greenfield M&A Source: TAC COFM from ThomsonOne and FDiMarkets In 2012Q1, only 2 European deals into China were greater than USD100mn: a USD365 mn acquisition by Arkema, a French company in the chemical sector, and an USD137mn Greenfield investment by Bosch, a German company in the automotive & transport sector. Overall, the EU27 operated 16 deals in the equipment sector and 13 operations in the other services in 2012Q1. In parallel, 75% of the total amount of Chinese ODI into the EU27 in 2012Q1 is explained by the USD1.0bn acquisition of Kalahari Minerals PLC in the UK by China Guangdong Nuclear Power. Kalahari s main asset is a 42.5% stake in Exctract Resources, which is developing the Husab Uranium project in Namibia. However, the largest number of Chinese deals in the EU27 is concentrated in the electronic/software/it sector (13 out of 34 operations). In parallel, China Investment Corporation (CIC), the nation s sovereign wealth fund, has shown a keen interest in two major European utilities, with a minority stake bought in GDF Suez s energy exploration and production business in December 2011, a French firm, and another minority stake in Thames Water, a UK utility group, the following month. Page 4

5 Key Facts on Hong Kong and Taiwan FDI inflows into Hong Kong and Taiwan are clearly of a lower magnitude and more unstable than in China. Outflows from Taiwan were usually higher than foreign inflows. It is also generally the case for Hong Kong Q1 Total inflows into (USD bn) China Hong Kong Taiwan Total outflows from (USD bn) China Hong Kong Taiwan In Hong Kong, 58% of investments went to China in 2012Q1, followed by Canada (with 32% of total amount invested, including a USD1.0bn M&A in Grande Cache Coal Corp). Those investments are particularly concentrated in the commodities & materials (35%) and the automotive & transport sector (25%). In Taiwan, most outflows go to the USA (64%), China (12%) and Japan (10%). These investments are focused on the chemicals (45%) (including a big Greenfield investment USD1.7bn by Formosa Plastics Corp), the electronic/software/it (29%) and the commodities & materials sectors (26% of total ODI). Page 5

6 COFM Statistics and Methodology This section aims at providing a medium-term view of FDI flows into and out of China over the period q1. Data from three different sources are used and compared: the TAC bottom-up approach (COFM), official Chinese data from MOFCOM and UNCTAD figures as reported in the World Investment Report. 2012Q1 2012Q1 It is worth noting that the differences between the three sources are not abnormal, since methodologies and concepts used in data collection vary from one source to the other. A detailed analysis of these discrepancies, such as the one conducted by TAC in a previous report for the European Commission (see the TAC - EU-China Economic Observatory), or Mlachila and Takebe (IMF, 2011), identify the following causes for differences and/or uncertainties: The accounting of reinvested earnings and changes in capital structures of existing foreign companies in China. The COFM database concentrates on new operations and new investments made from abroad into China. By construction, these figures do not incorporate what is happening within existing foreign companies operating in China. Conversely, MOFCOM reports that it includes reinvested earnings (the share of profits made by foreign companies in their operations in China that are not transferred as dividends). There is also an uncertainty on the treatment by MOFCOM of changes in the capital structure of foreign invested enterprises (FIEs): the standard IMF methodology when dealing with FDI figures is to deduct any purchase of equity capital in FIEs by domestic investors from foreign investors ('netting'), but MOFCOM does not explain its own statistical treatment and it is not unreasonable to believe that such amounts of such transactions are not deducted in the Chinese statistics. For a better comparison, it is therefore safe to assume that we should statistically add reinvested earnings reported in the IMF balance of payment statistics under the heading: Direct investment in China. The graph below shows reinvested earnings as indicated in the IMF Balance of Payment Statistics for China. A plausible over-reporting of FDI inflows in MOFCOM figures. Almost since China opened up to foreign direct investment have there been repeated comments about potential over-reporting of FDI inflows because of operations conducted by Chinese corporations using their affiliates abroad to (re)invest in China. The main rationale for such operations was related to the significant fiscal incentives provided Page 6

7 to foreign investors. Interestingly, an observation of the number of operations reveals a parallel trend over time. A plausible under-reporting of FDI outflows in MOFCOM figures. In principle, investments abroad need to be pre-approved by MOFCOM, but in practice, small-scale investments do not necessarily go through this process. The recent administrative reforms allowing such authorization processes to be decentralized for smaller outward investment operations is likely to increase the degree of underreporting. Chinese investment abroad by intermediaries of their subsidiaries or affiliates operating outside China (Hong Kong, Macao and offshore destinations such as the Cayman Islands) appears not to be properly included in MOFCOM data. Complex financial structures designed for large infrastructure or commodity-related investments appear not to be included in MOFCOM's data, probably because they may be considered more as 'project finance types of investment rather than direct investment. COFM includes such operations when the provider of funding for any special purpose vehicle is ultimately a Chinese entity. A similar remark is valid for outward FDI related to official bilateral aid flows from China (so-called 'Angola Mode', where it is virtually impossible to disentangle genuine FDI from bilateral aid and suppliers/construction contracts). Problems of missing or incomplete data in the COFM database. The two providers of raw data (FT FDiMarket and Thomson One) admit that amounts may be missing for small operations, however estimates suggest that the impact of these missing amounts would be limited to less than 10% of the total. The absence of detailed information and data discrepancies have become more of an issue as the overall amount of Chinese outward FDI has substantially increased. The degree of attractiveness of different countries for China s ODI is becoming a new policy dimension taken onboard by officials everywhere, including the EU, while symmetrically the absence of detailed information feeds into worries about China s ownership of sensitive or large assets in foreign countries. About this report A report written with detailed data on greenfield investments (provided by FT fdimarkets) and merger and acquisitions (provided by Thomson One), updated up to end March The contents of this publication are the sole responsibility of TAC and can in no way be taken to reflect the views of the European Union or the European Commission. For more information on the database and connection possibilities, please contact Filip Deraedt, DG Trade. Page 7