In recent days, corruption probes have engulfed top officials in a sector that is integral to President Xi Jinping’s “Made in China 2025” ambitions. At least three senior executives of a $20 billion public equity fund set up in 2014 to invest primarily in chipmaking have been arrested; so has Xiao Yaqing, the head of the country’s industrial policy agency and the most senior incumbent cabinet official who has been embroiled in a disciplinary investigation in nearly four years.
It is intriguing that the anti-corruption agency is looking into a leading venture capital fund that has delivered substantial results. Phase 1 of the National Integrated Circuit Industry Investment Fund has raised billions from the Ministry of Finance and China Development Bank Capital. Between 2014 and 2019, the so-called Big Fund invested in 23 chip companies, producing one national champion after another. It has backed Semiconductor Manufacturing International Corp., whose advanced chipmaking capabilities could put it ahead of its American peers. He also established Yangtze Memory Technologies Co., a subsidiary of Tsinghua Unigroup Co., China’s best bet in NAND flash memory manufacturing.
Does this mean that the state-run venture capital model that flourished under Xi’s rule no longer works? Government-owned venture capital funds have raised around 6.2 trillion yuan ($920 billion), almost all of it in the eight years to 2021. These funds have become a key source of funding for private companies , contributing about 10% of the total capital raised last year.
The Big Fund and thousands of so-called government guidance funds are designed to mimic venture capital. End investors – for example, the Ministry of Finance in the case of the Big Fund – are not involved in the fund’s day-to-day operations or investment decisions. And the funds themselves are largely passive stakeholders in the companies they create.
The Big Fund’s involvement in flash memory maker YMTC is a good example. It brought 49% of the initial capital, much more than the 13% of the parent company Unigroup. But he did not control YMTC.
This model was intended to encourage best practices in corporate governance. After all, what do bureaucrats know about running businesses? However, with government investment – and the prestige that comes with it – portfolio companies can easily go haywire. The prestige of this orientation fund opens the doors to loans but can lead to excessive borrowing.
Big Fund’s entanglement with Unigroup ended in tears. At its peak, Unigroup’s empire had nearly 300 billion yuan in assets and 286 consolidated subsidiaries. But it also boasted a net debt-to-equity ratio of 125%, defaulted in 2020, then restructured into bankruptcy. Its longtime chairman, Zhao Weiguo, was arrested in mid-July, possibly over investigations into related-party transactions, financial news outlet Caixin reported.
Guidance funds are notorious for using their reputation for leverage. An initial contribution from the government – often seen as a stamp of approval – can attract several multiples of the sum of other investors, it is thought.
Gavekal Research gave a good example: the huge 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 for a group of subfunds. These sub-funds, in turn, aspired to catalyze 1 trillion yuan in additional capital, equivalent to almost a third of Hubei’s annual economic output.
But who are the co-investors? A significant share came from banks’ wealth management products, a form of shadow funding. Local government financing vehicles, which are largely loan-funded shell corporations, are also big participants.
In other words, these state-sponsored venture capital funds enabled already indebted Chinese companies to borrow even more. Investments by guidance funds, including those in strategic emerging sectors, are expected to slow this year, according to Fitch Ratings.
After the passage of the flea law, there is still a nagging debate about whether the US government is doing enough. The legislation includes $52 billion in grants to support advanced chip manufacturing as well as research and development in the United States. That’s not a lot for state-of-the-art manufacturing plants that cost over $10 billion to build. And its scale is matched only by the Big Fund and its co-investors, which collectively increased China’s chipmaking capacity by $70 billion in the five years between 2014 and 2019. There were thousands other Chinese guidance funds there, supporting fledgling industrial technology companies. .
But this debate is misguided once we delve deeper into China’s state-led industrial model. Yes, China has outstripped its competitors in some strategic technologies. But behind every success are many more stories of waste, broken promises, corruption scandals and misuse of capital, all 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 industrial glory from China?
More from Bloomberg Opinion:
• How China copied South Korea all wrong: Shuli Ren
• What happened to the US electric vehicle supply chain? : Anjani Trivedi
• Chips Act ignores US leaders for Asian winners: Tim Culpan
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. A former investment banker, she was a markets reporter for Barron’s. She holds the CFA charter.
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