By Gleb Kuznetsov, Corey Sullivan, and Purav Bhandare (University of Queensland)
Report Head: Timur Kurbanov (New York University Shanghai)
Australia has entered its first recession in 29 years having borne the devastating effects of the bush fires and COVID-19 in Q1 2020. GDP contracted by 0.3% in Q1 2020, with the June quarter expected to be even worse. The Reserve Bank of Australia has implemented quantitative easing for the first time, targeting the shorter end of the yield curve, which has seen the RBA’s balance sheet expand by ~59% from 1st January to 1st July. The cash rate target has also remained at 0.25%.
In Japan, March saw a 3.4% seasonally adjusted real GDP contraction, and the Cabinet Office is forecasting a contraction of 21.5% in the second quarter of 2020. Japan’s fiscal stimulus packages in the face of COVID-19 total US$2.18 tn, ~40% of GDP. To help finance this, government debt issuance will rise to 212 tn Yen in FY20 (US$2 tn). Japan’s debt dependency will rise to a record 56.3% following this.
India’s macroeconomic outlook is bleak even after lockdowns are starting to lift, with the IMF predicting a 4.5% contraction from 2QCY2020 to 2QCY2021. Tax revenues are set Geopolitical & Macroeconomic Outlook Quarter 2 New Zealand Australia India China Japan to crash, and India’s debt-to-GDP ratio may jump to 90%. Since March 2020, demand from urban and rural parts of the economy have collapsed, with investment activity and private consumption suffering declines. India’s imports fell 60% (YoY) in April, with the Central Bank’s inflation outlook remaining highly uncertain. Hence, in May 2020, India’s cash rate (repo rate) was reduced by 40 bp from 4.4% to 4%. The Insolvency and Bankruptcy Code, introduced in 2016, gave rise to many distressed M&A transactions since inception, and it is expected to continue driving M&A in the future, especially after its 6-month moratorium ending late September.
Australia & New Zealand
Pressure on the Banking sector
The past year has seen Australia’s financial sector, in particular the ‘Big 4’ consumer banks, rocked by several scandals, first starting from the Hayne Royal Commission in December 2017. Recent RBA rate cuts have further eaten into the banks’ margins, while provisions for bad debt have risen in lieu of COVID19. Financial regulators have also urged banks to use their capital buffers as the sector deals with $236 bn of deferred loans, which will be even more vulnerable when the scheduled Government stimulus ends in September. We have seen banks divesting from other ventures to ‘put banking first’ - exemplified by Westpac’s sale of its remaining 9.5% share in investment manager Pendal and CBA’s sale of 55% of Colonial First State to KKR for A$1.7 bn subject to regulatory approval.
Foreign Investment Review Board Changes
If passed, new changes to the FIRB will see the threshold for foreign investments in sensitive national security businesses lowered to $0 as of 1st January 2021. This will effectively require the FIRB to approve any foreign investment case-bycase and provide the Treasurer with a range of new powers to unwind transactions. This comes on the back of the rhetoric to protect the ‘national interest’, especially from foreign investors exploiting the low AUD. All monetary screening thresholds have been temporarily lowered to $0 as of 19th March as a response to coronavirus. This will make it harder to convince foreign buyers to participate in Australian deals - a potential drag on M&A activity given only 20% of Australian M&A, by value came from domestic bidders in FY19.
The past quarter has seen a significant escalation in Australia’s tensions with its primary trade partner. Australia’s recent calls for an enquiry into China’s handling of COVID-19; disagreements over HongKong; and points of the Belt and Road Initiative have triggered economic and political backlash. China has imposed 80.5% tariffs on Australian barley exports, with threats of tariffs on Australian coal and the discouragement of international students from studying in Australia. Investor confidence in the real estate and resources sector will be weakened due to their sensitivity to Chinese demand; the mining sector saw a 20% drop in M&A activity in Q2 following global demand disruptions and escalating tensions.
Insolvency and Bankruptcy Code
The Insolvency and Bankruptcy Code (IBC) introduced in 2016, created a single law for insolvency and bankruptcy. The Code was essential as the insolvency resolution process took 4.3 years on average in India in 2015, compared to 1 year in the UK and 1.5 years in the US. The Code gave rise to many distressed M&A transactions, with the industrial sector being the most successful in resolution - Essar Steel’s $5.7b acquisition of Essar Steel being the largest and most notable distressed M&A transaction. A recent amendment imposed a moratorium on insolvency applications for a period of 6 months starting March 25th, 2020. This is critical to protect corporations experiencing COVID-related distress from being pushed into insolvency proceedings under the IBC. Following this period, given some of the permanent distress caused by COVID-19, it is expected that the number of IBC-related M&A transactions should increase.
Early in the second quarter, India amended its foreign direct investment policies in anticipation of possible predatory behavior from international bidders. The rules prevent opportunistic takeovers by Chinese companies, reducing any prospects of inter-country M&A between the nations. Tensions between the nations escalated when 20 Indian soldiers died fighting at a border site, which led to the majority of Indian population adopting a nationalistic mindset. “Boycott China” is a sentiment shared by the Indian population, however, China supplies 70% of India’s drug intermediates and India’s smartphone sector heavily relies on cheap phones made by Chinese companies such as Oppo, Xiaomi. Hence, boycotting products or services where there are alternatives available might be more effective. As such, India recently banned 59 Chinese apps, including the popular messaging chat WeChat and video-sharing app TikTok.
Given that investment has been shrinking over the last few years, the government has been trying to increase spending to fuel economic growth, with spending rising by 12% since last year, leading to a fiscal deficit in 2019 that was 4.6% higher than the deficit six years ago. This GLOBAL M&A OUTLOOK REPORT – Q2 2020 15 deficit, as well as the recent policy measures have been praised as having “increased economic activity”, however, the government has used their crucial tool - spending. Hence, they have few tools left for the near future and economic recovery is likely to take over two years rather than a few months. This is likely to reduce domestic M&A activity in the short-term, especially given that IBCrelated M&A is also on hold for six months.
Tensions on the Rise
2020 has welcomed fresh tensions between China and a large proportion of the Western world, most importantly the U.S., as it faces pressure regarding an independent query into the origins of the coronavirus. China’s response to Australia’s query, in particular, was to impose 80.5% tariffs on Australian barley exports, with threats of tariffs on Australian coal and the discouragement of international students from studying in Australia. In particular, China has been subject to President Trump’s demand that they pay for the outbreak, and a large amount of doubt is cast over the future of the first phase of the historic trade deal between the two nations. In particular, federal funds from the U.S. are blocked from entering China’s markets and has effectively shut off China’s capital markets to U.S. investors.
Hong Kong Security Law
Furthermore, the last three months have seen the imposition of China’s new security law, which aims to crack-down on pro-democracy protests in Hong Kong. So far, over 400 protestors have been arrested. The Hang Seng Index remains volatile, and there remain questions over the robustness of the peg between HKD and USD. Such uncertainty over Hong Kong has inevitably caused business and consumer confidence to new lows, dampening M&A activity throughout the region where many of the world’s investment banks operate.
China’s Manufacturing Sector Under Threat
The fate of China’s economy as it battles with the long-term impacts of the Coronavirus is of crucial importance to almost all countries. It will have a significant effect on M&A activity going forward. Indeed, the shut-down of a substantial proportion of Chinese factories during the pandemic welcomed depressed figures surrounding its manufacturing and service sectors, validating informal indications that the country will struggle to return to work. Nonetheless, as domestic cases fall, and China’s economy slowly opens up, there remains optimism thanks to China’s brutal efficiency and its ability to regain growth momentum over the last month. Industrial production and services output, China’s main focus in persevering GLOBAL M&A OUTLOOK REPORT – Q2 2020 16 through the crisis, has resumed growth and economists believe the economy will narrowly avoid a technical recession, with GDP expected to expand at least 1.5% in the second quarter relative to 2019Q1 levels.
On March 24th, the Tokyo 2020 Olympic and Paralympic Games were postponed. Estimates place the effect of the postponement at close to US$ 6 bn. If the games are cancelled, it will cost Japan US$ 42 bn. This has significant impacts on various venues that are forced to cancel any events they had planned for 2021 to host the Olympics; broadcasting companies globally; and the tourism sector. Domestic consumption is set to suffer from the postponement as well as the insurance sector. This is expected to further slow M&A in the insurance sector, as companies weigh the impact of COVID-19 and the postponement of the Olympics on insurers’ bottom line.
Around Asia-Pacific, political tensions are contributing further uncertainty to already volatile markets. Q3 should hopefully see more growth and M&A activity than in the first two quarters of the year - though this is subject to the amelioration of COVID-19. Another trend that appears to be prevalent across the region is the consolidation of industries and divestments as industries suffer for various reasons. Political tensions, embodied in various investment policy changes, will add further headwinds to cross-border M&A flow, in addition to COVID-19.