Escalating conflicts between China and the West are putting Chinese investment at risk and have far-reaching implications on the UK’s net zero commitments.
Political risk is now firmly back in the corporate lexicon. Once the preserve of corporates operating in volatile emerging market economies, the concept re-emerged in Europe and North America after the Great Recession. With the economic fallout of 2008 turbo-charging political and cultural fissures within Western societies, decades of benign stability have given way to volatility and uncertainty.
In recent years, corporates have had to navigate a wave of political shocks from the eurozone crisis, Brexit and the US trade war, whilst also adjusting to a more interventionist state and a febrile atmosphere amongst employees and consumers as social issues rise in salience. This makes for a much more arduous business environment and the beginning of an era of post-liberalism.
Recent developments in the China-US trade conflict highlight the costs of political risk for developed markets. The recent decision of the UK to ban Huawei from the 5G network represents a further deterioration in geo-political relations between China and the West. However, concerns should not just be limited to the so called ‘telco war’. With post-liberalism ushering in a new era of protectionist impulses across developed markets, and new scrutiny against China in particular, the future of Chinese investment remains uncertain.
Reference: WTO trade database. Graph shows large increase in protectionist (harmful) trade measures from G20 countries since 2009 .
China and low carbon investment
Chinese investment in the UK has increased in size and significance, amounting to $83b of Foreign Direct Investment (FDI) since 2005. Much of this investment has been targeted at the energy and utilities sector, where China now controls 25% of North Sea oil production after major investments in Talisman Energy, BP and INEOS Britain amongst others.
Source: China Global investment tracker by the American Enterprise Institute and The Heritage Foundation.
Chinese investments in renewables are seen as a core component of driving the UK’s energy transition. Investment in UK wind power for example has been notable with a $1b investment in the Dudgeon and Beatrice farms in 2017 alone.
However, the heightened political hostility between the UK/US and China means the future of this investment is uncertain. The introduction of the UK National Security Investment Bill expected in 2020 would afford ministers a veto on foreign acquisitions and investments, and mark a decisive shift away from the open market economy we are accustomed to, leaving future Chinese investment open for debate and scrutiny.
Of particular note is China’s commitment to the next generation of UK nuclear power stations. China’s ambition of building, financing and running a power station in Sizewell is facing increasing criticism as distrust accentuates long-withstanding security concerns.
Source: Redfield and Wilton UK polling April 30th
The UK therefore faces a dilemma in the years ahead. Pressure to maintain a strong western alliance from America, the EU, and traditional allies in the Asia Pacific such as South Korea, Australia and Japan will continue to incentivise scrutiny in regards to Chinese involvement in the UK economy, especially where security concerns remain palpable.
However, the Johnson administration’s ‘levelling up’ economic agenda for the British regions, targeting the green economy in particular to provide new employment opportunities post-Brexit and post-Covid, and deliver the country’s net zero commitments, depends on large increases in capital and investment spending across the UK.
The dependence on private capital to pursue this agenda is increasing as the UK’s response to Covid-19 produces a rapid deterioration in the UK’s fiscal position. The country’s debt-to-GDP ratio is expected to break the traditionally perceived ‘sustainability threshold’ of 100% of GDP this year. As a consequence, future relations with investment partners such as China are of particular significance to the UK, and heighten the costs of escalating political risk for the UK government.
Source: ONS Debt Statistics
Escalating political risk has very tangible consequences for the UK, whether that being a delay to the country’s 5G ambition or frustrating green investment targets. The evolution of Chinese relations with the West represents a major political risk in the years ahead.
Political risk accounts for a wholly new risk class for most corporates. Investing in the appropriate risk management frameworks now will enable firms to monitor and manage these evolving risks in the future, thereby minimising the costs and maximising the opportunities of this increasingly volatile world.
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