China’s industrial policy seems to have fans across the Pacific. The US’ US$280 billion Chips and Science Act is a direct response from US President Joe Biden’s administration to Beijing’s spending on key industries.
However, as the likes of Intel and Micron Technology jostle for a slice of US government support, the perils of relying upon public money are also sending shock waves through China’s chip industry.
Recent corruption investigations have engulfed top officials in a sector that is integral to Chinese President Xi Jinping’s (習近平) “Made in China 2025” ambitions. At least three senior executives from a US$20 billion state-owned private equity fund, set up in 2014 to invest in chip manufacturing, were detained; so was Xiao Yaqing (肖亞慶), the head of the agency in charge of the nation’s industrial policy and the most senior sitting cabinet official ensnared in a disciplinary probe in almost four years.
Illustration: Yusha
It is intriguing that the anti-corruption agency is looking into a top venture capital fund that has yielded substantial results. Phase one of the National Integrated Circuit Industry Investment Fund raised billions of US dollars from the Ministry of Finance and China Development Bank Capital. Between 2014 and 2019, the so-called Big Fund invested in 23 chip companies, churning out one national champion after another.
It backed Semiconductor Manufacturing International Corp, whose advanced chipmaking abilities might put it ahead of its US peers. It also seeded Tsinghua Unigroup Co subsidiary Yangtze Memory Technologies Co (YMTC), China’s best bet in NAND flash memory manufacturing.
Does this mean the state-run venture capital model, which flourished during Xi’s reign, no longer works?
Government-owned venture capital funds raised about 6.2 trillion yuan (US$917 billion), almost all in the eight years through last year. These funds have emerged as a key funding source for private companies, contributing about 10 percent of total capital raised last year.
The Big Fund and thousands of so-called government guidance funds are designed to mimic venture capital. The ultimate investors — for instance, the Ministry of Finance in the case of the Big Fund — are not involved in daily fund operations or investment decisions. The funds themselves also tend to be passive stakeholders in the companies they seed.
The Big Fund’s involvement in the flash memory maker YMTC is a good example. It contributed 49 percent of the initial capital, much more than the 13 percent from parent Unigroup — although it did not control YMTC.
This model was intended to encourage best practices in corporate governance. After all, what do bureaucrats know about running companies?
However, with government investment — and the prestige that comes with it — the portfolio companies can easily go haywire. Although prestige opens doors to loans, it can also lead to excessive borrowing.
Big Fund’s entanglement with Unigroup ended in tears. At its peak, Unigroup’s empire had close to 300 billion yuan in assets and 286 consolidated subsidiaries.
However, it also touted a net debt-to-equity ratio of 125 per cent defaulted in 2020 and then went into a bankruptcy restructuring. Its long-time chairman Zhao Weiguo (趙偉國) was detained last month, possibly for investigations into related-party transactions, as reported by financial media outlet Caixin.
Guidance funds are known for the use of their reputation as leverage. An initial contribution from the government — often seen as a stamp of approval — can attract many multiples of the sum from other investors, the thinking goes.
Gavekal Research gave a good example: The massive Yangtze River Industry Fund that Hubei Province established in 2015. The provincial government initially injected 40 billion yuan into the parent fund, with the aim of raising 200 billion yuan for a group of sub-funds. In turn, these sub-funds aspired to catalyze 1 trillion yuan of additional capital, the equivalent of almost one-third of Hubei’s annual economic output.
Who are the co-investors? A sizable chunk came from banks’ wealth-management products, a form of shadow financing. Local governments’ financing vehicles, which are largely shell companies funded by loans, are also big participants.
Essentially, these state-sponsored venture capital funds enabled China’s already indebted corporates to borrow even more. Guidance funds’ investments, including those in strategic emerging sectors, are expected to slow this year, according to US credit rating agency Fitch Ratings.
Upon the passage of the Chips Act, there is still nagging debate as to whether the US government is doing enough. The legislation includes US$52 billion of grants to support advanced chip manufacturing as well as research and development in the US. That is not much for cutting-edge manufacturing plants that cost more than US$10 billion to build. Not to mention its scale matches only the Big Fund and its co-investors, which collectively expanded China’s chip manufacturing capacity by US$70 billion between 2014 and 2019. There were thousands of other Chinese guidance funds out there, propping up nascent industrial technology firms.
However, that debate is misguided once we dig deeper into China’s state-directed industrial model. Yes, China has leapfrogged competitors in some strategic technologies. Yet behind every success are many more stories of waste, broken promises, corruption scandals and misuse of capital — while adding to a troublesome pile of corporate debt.
Is the US willing to borrow billions more for projects that can easily go sour, just to reclaim its manufacturing glory back from China?
Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. A former investment banker, she was a markets reporter for Barron’s. She is a CFA charterholder.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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