Image Credit: Photo by Remy Steinegger / Copyright: World Economic Forum

Evidently, it is not only Indian politicians who protest the sale of domestic entities to foreign companies citing tenuous arguments of loss of national sovereignty. Our northern Communist neighbour is also not above such considerations, if the latest Carlyle-Xugong fiasco is any indication.

The world's second- largest private-equity firm, Carlyle Group, yesterday said it has dropped its plan to invest in China's Xugong Group Construction Machinery Co, citing ''significant changes in the market environment.''

''Both parties have decided not to proceed with the investment and Xugong will embark independently on its restructuring,'' Carlyle said in joint statement with the Chinese building machinery maker, without elaborating. Agreements under which Carlyle and Xugong discussed first a takeover and then a minority investment have expired, the companies said.

Carlyle's bid for Xugong Group was closely watched amid US government warnings about possible Chinese protectionist sentiment. Beijing stepped up scrutiny of foreign acquisitions following the Carlyle bid and enacted a rule last year requiring a national security review of such deals.

Carlyle had tried to buy Xugong in 2005, offering $375 million for 85 per cent of the company, when the Chinese stock market was in a slump. Xugong said it wanted the investment in order to grow in a market dominated by US-based Caterpillar Inc. and Japan's Komatsu Ltd. The government of the eastern Chinese city of Xuzhou, which owns Xugong, approved the deal.

But the bid sparked complaints about asset sales to foreigners. China is the world's leading destination for foreign investment but the takeover of existing companies is still unusual.

Opposition to the deal was led by Xiang Wenbo, chief executive of Sany Heavy Industry, Xugong's smaller rival. He started a personal blog to criticize the deal and used the web to reveal that the company wanted to bid for Xugong.

"What Sany is doing is for itself and for the country, because manufacturing is a national strategic industry," Xiang wrote in a bid to stir up nationalistic sentiments.

Evidently, he succeeded, for soon after, Chinese authorities announced that big mainland equipment makers had to consult Beijing before selling a stake to overseas investors.

Some analysts say that the proposed investment had been felled by the bilateral trade disagreements between the US and China over market access.
 The outcry prompted Washington to express concern about the handling of such offers.

Xugong will likely now solicit an investment from a domestic investor, possibly a local private equity firm, to further its corporate aims. And Carlyle believes that "Xugong's expansion will create opportunities for partnership with both Carlyle and its portfolio companies worldwide".

In August 2006, central government ministries held an unprecedented gathering of top officials to try and break the impasse. Carlyle later twice scaled back its planned investment in an effort to secure approval, but even agreeing to a minority stake of 45 per cent failed to turn round the Beijing bureaucracy.

US officials have expressed concern that official Chinese support for foreign participation in the country's economy might be weakening now that the country has met its market-opening pledges to the World Trade Organization.

Carlyle insists that the Xugong experience was a one-off. It continues to operate in China and has invested in more than 30 mainland companies, deploying about $1.3 billion in equity alone in China over the past two years. But, like most of its global private equity rivals, the vast majority of investments are not buy-outs but come in the shape of minority stakes that do not cause alarm in Beijing.

In its statement on Tuesday, Carlyle tried to mask its disappointment and said it "values the relationships it has developed with the many Chinese government agencies it has worked with throughout the years". With the realities of politics, there's not much else it could have said.