Since the beginning of this year, China's foreign economy has faced significant pressure amid changes in the external environment. On one hand, despite a rapid growth in foreign exports during the COVID-19 pandemic, there has been a gradual decline shown as negative growth since June which only turned positive in November. Its contribution to economic growth has been somewhat lagging. On the other hand, foreign direct investment (FDI) has experienced rare negative growth, even when excluding the pandemic year of 2020. In fact, since the second quarter of this year, FDI in the country has shown negative growth. The Ministry of Commerce did not publish the relevant data as scheduled; the latest data indicates that from January to October 2023, the number of newly established foreign-invested enterprises nationwide increased by 32.1% year-on-year to 41,947, while the actual use of foreign capital amounted to RMB 987.01 billion, a year-on-year decrease of 9.4%. Despite the growth in the number of new enterprises, there is a noticeable decline in investment amounts. This situation also signals that the external impact is weakening the contribution and participation of foreign trade and overseas investment to China's economy regarding investment demands.
Regarding the decline in FDI and the foreign capital outflow that has become a concern, a relevant official from the Central Finance Office recently responded that the recent fluctuations in foreign investment data are multifaceted, influenced by both economic and non-economic factors. First, there has been a profound change in the external environment. Geopolitical risks have significantly increased, with some countries promoting the return of industries and funds while introducing investment restrictions related to China. Developed countries and emerging economies have adopted large-scale preferential policies, which intensifies international competition for investment. Second, the COVID-19 pandemic has disrupted offline exchanges, leading multinational companies to lack an understanding of China's actual situation, even to some extent, resulting in misunderstandings that affect investment decisions. Third, labor costs in China are rising, which reduces its low-cost advantage. Some labor-intensive industries are experiencing a shift due to changes in comparative advantages. This is economically determined and normal.
China's Cumulative Year-on-Year FDI Growth
Source: National Bureau of Statistics & Ministry of Commerce websites. Chart plotted by ANBOUND.
In fact, whether considering internal factors such as economic transformation and industrial upgrading within China itself or external factors such as increased geopolitical risks and the global restructuring of industrial chains, the outflow of foreign capital is indeed normal. During periods of transition, fluctuations in investment are not unexpected. However, the abnormality lies in the country's Ministry of Commerce no longer publishing the relevant data as scheduled. According to data, although foreign enterprises account for less than 3% of the total number of enterprises in China, they contribute to 2/5 of China's foreign trade, 1/6 of tax revenue, and nearly 1/10 of urban employment. This indicates their significant role in the country's economic growth and high-quality development. Researchers at ANBOUND have emphasized that the current trend of foreign capital outflow from China, strengthened for various reasons, poses a risk to its economy if it continues.
Despite the eruption of the U.S.-China trade war in 2018 and the escalating geopolitical competition between the two nations since then, in the past three years, even including the impact of the COVID-19 pandemic, there has been a continuous increase in China's actual utilization of FDI. The figures show an upward trend: USD 144.37 billion in 2020, USD 173.48 billion in 2021, and even reaching USD 189.13 billion in 2022. However, it is only this year that foreign investments show a noticeable outflow trend. This suggests that, despite external and uncontrollable factors, the main reason for the decline in FDI is likely internal changes within China. Researchers at ANBOUND noted that the market signals reflected in the net outflow of foreign capital need sufficient attention, prompting a reassessment and reflection on the current changes in the Chinese market environment.
From the perspective of foreign enterprises, China's economic and market factors are also among the primary considerations for foreign investment decisions. Not long ago, Goldman Sachs noted China's economy is currently slowing, and the real estate sector continues to drag down the Chinese economy. Additionally, changes in domestic and international economic policies and environments, the substantial withdrawal of foreign investments, the tension in the job market, and the significant financial pressure on local governments further exacerbate the uncertainty. It is evident that changes in China's economic situation, leading to increased market volatilities, are also factors that cannot be ignored in the foreign capital outflow.
Tao Wang, Managing Director and Head of Asia Economic Research at UBS investment bank, stated that the net FDI in the third quarter was negative USD 11.8 billion, an unprecedented occurrence. She explained that the decline in FDI is due to structural, cyclical, and short-term factors. Firstly, impacted by the pandemic, the profits of China's entire industrial enterprises have notably declined, leading to a decrease in reinvestment of retained profits. Additionally, amid the pressure of the U.S.-China trade conflict and decoupling from China, foreign capital may reduce exposure to China and increase the relocation of retained profits. Secondly, influenced by strict regulations and U.S. restrictions on technology investments in China, private equity investments in the technology sector have seen a greater decrease. Private equity, venture capital, and other investments have declined rapidly in the past two to three years. Thirdly, the U.S. interest rate hike has led to a sharp increase in financing costs. Therefore, the considerable interest rate differential between the Chinese and foreign markets will also impact the data on FDI. Tao Wang further noted that looking at long-term structural issues, it is quite difficult and not optimistic for foreign capital to recover to the average level of the past decade. She added that recovering half of the past decade would already be considered quite good. In this regard, whether it be technical or environmental factors, changes in the economy and market themselves significantly influence the direction of foreign capital flows.
Researchers at ANBOUND believe that under the trends of global industrial chain restructuring and continuous upgrading of the Chinese economy and industries, foreign investment in China is bound to change. Cost-driven foreign investment will gradually exit, and market-driven foreign investment will continue to enter the Chinese market as the domestic market expands and demand increases. Under this trend, there is a need for China to adjust its policies toward foreign investment to gain trust through market openness, as well as to instill confidence in foreign enterprises. China's Central Economic Work Conference has also proposed actively stabilizing the basic foundation of foreign trade, accelerating the cultivation of new foreign trade momentum. This reflects a positive and encouraging attitude towards foreign investment and foreign enterprises in terms of policy.
It should be noted that although the Chinese government, from the central to local levels, still attaches great importance to attracting foreign investment, and the State Council has issued relevant policies to encourage and attract foreign investment, the actual market environment in China has changed. For example, on the one hand, driven by the policy of high-quality development, some regions are eager to replace old with new, focusing only on high-tech "new track" companies, and treating foreign enterprises in the traditional manufacturing sector differently. This has led some foreign enterprises to consider leaving. On the other hand, in the context of increased geopolitical risks, the Chinese government and enterprises are overly focused on factors such as "self-reliance and controllability", creating non-market barriers for foreign-funded enterprises. This is tantamount to partially closing the market door to foreign enterprises, making it difficult for them to access the Chinese market. As a result, some foreign enterprises may hesitate to enter the Chinese market, or even exit it.
In the process of promoting high-quality development, the role and significance of government policies are increasing. Not only is there a continuous increase in macroeconomic regulation, but micro-level control is also strengthening through "precision regulation". This has led to significant changes in the Chinese market's ecology and functionality, impacting not only the confidence of foreign investors but also of private enterprises as well. To attract foreign investment and build a healthy and potential-rich market environment would be more attractive than various preferential policies and commitments. For this reason, ANBOUND has repeatedly emphasized adhering to the original intention of a market economy.
Final analysis conclusion:
China is experiencing a trend of net outflows in foreign direct investment (FDI), influenced by various factors such as economic transformation, industrial upgrading, geopolitical risks, and the restructuring of industrial chains. However, the primary considerations for foreign investors are the changes in the Chinese market environment and economic conditions. To attract foreign investment and enhance openness, the focus should not only be on preferential policies but also on maintaining and supporting the market environment. This will enable investors to see the determination of the Chinese authorities to adhere to the development of a market economy.
