China’s Structural Outflow Of Foreign Investment Remains A Serious Challenge – Analysis

By Yang Xite

In the process of stabilizing the economy in China this year, two major microeconomic groups have attracted significant attention, namely private enterprises and foreign enterprises. The Chinese government has demonstrated strong support for both, mainly through high-level endorsements, communication and reassurance, policy support, and enhanced services. The goal is to bolster the confidence of these enterprises in the Chinese market.

However, in recent years, there have been some subtle changes in the development of foreign investment in China, the country's policies towards foreign investment, and the actual conditions faced by foreign-invested enterprises. Some of these changes are noteworthy, while others are even concerning. It is not an exaggeration to say that China's attitude, policies, and actions regarding foreign investment could, to some extent, affect the country's future development and security. Therefore, changes related to foreign investment warrant close attention and thoughtful consideration from government agencies, policymakers, and market participants in China.

ANBOUND’s founder Kung Chan noted that China is currently experiencing a trend of "structural loss" in foreign investment. This "structural loss" refers to the fact that the withdrawal of foreign capital is not merely a cyclical phenomenon but involves various structural adjustments across the industry chain, supply chain, and upstream and downstream sectors. Many believe that foreign investment will return as soon as China's economic environment improves, but this is not as straightforward as imagined. As it stands, the arrival and departure of foreign investment are tied to complex structural issues. Once foreign investment leaves and repositions itself globally, achieving structural stability, it becomes exceptionally difficult to lure that capital back to China.

Moreover, such global investment structural shifts can trigger an acceleration effect. Even foreign investors reluctant to leave might be compelled to follow the trend and invest in other countries due to structural factors. This means that for the Chinese authorities, merely focusing on the movements of one or two foreign-invested enterprises is insufficient. The real focus should be on changing the broader market environment to address these issues closely linked to structural factors.

From a macroeconomic perspective, in the first half of this year, the number of newly established foreign enterprises in China reached 26,870, a year-on-year increase of 14.2%. However, the actual amount of utilized foreign investment was RMB 498.91 billion, a year-on-year decrease of 29.1%, with the decline widening compared to the period from January to May. The peak of foreign investment in China was in 2022 when it reached RMB 1,232.7 billion. Since then, foreign investment in China decreased by 8% in 2023, and in the first half of this year, it fell by 29.1% year-on-year. Considering both domestic and international circumstances, China's foreign investment has entered a phase of trend-based decline, with the current steep drop being particularly alarming and warranting high domestic attention. Recently, researchers at ANBOUND have conducted surveys and discussions with several foreign investment stakeholders to understand their views on the Chinese market and the challenges they face. The main concerns foreign investors have about China can be categorized into several types.

First, there is concern about the potential deterioration of U.S.-China relations. Foreign investors generally believe that the worsening of geopolitical relations between the U.S. and China has significantly altered the perspectives of the U.S. and other Western countries toward China. They contend that if U.S.-China relations were to deteriorate significantly, the impact would be global. In the event of a conflict between the two countries, the global economy, society, and security would face substantial disruptions. Foreign investors see the Taiwan issue as a potential trigger for significant deterioration in U.S.-China relations or even conflict. Many of them believe that a major crisis in the Taiwan Strait could potentially lead to war between China and the U.S., making it challenging for the global economy and trade to sustain. It is noteworthy that the broader backdrop of worsening U.S.-China relations has already led to some restrictions on foreign investment in China. For instance, in certain policy-permitted sectors, foreign investment expansion has been affected. This is not due to issues with Chinese policies but rather because U.S.-China relations have directly influenced the expectations and decisions of foreign investors.

Second, there is concern about the possibility of a comprehensive decoupling between the U.S. and China. Foreign enterprises operating in China are almost universally opposed to a full decoupling between the two countries. Their stance is more rational compared to some American politicians who advocate for decoupling. Some U.S. companies have observed that most U.S. financial and economic officials do not want to fully decouple from China. However, there is relatively broad support in the U.S. for "de-risking" policies in certain specific areas. Hence, official statements from the U.S. government regarding "decoupling" and "de-risking" carry a certain degree of credibility. Foreign investors have noted that the communiqué from the Third Plenary Session of the 19th Central Committee explicitly calls for enhancing the self-reliance and controllability of industrial and supply chains, with a focus on key areas such as integrated circuits and industrial mother machines (i.e., "equipment for producing equipment"). This raises the question of whether China is preparing for potential decoupling from the U.S. in these areas, to mitigate possible disruptions in the supply chain or technological blockades.

Third, the stories of foreign investment development in China have not been effectively communicated. As a result, there is an "investor panic" among some foreign investors. In the current political climate, foreign businesses in China face complex challenges. Confidence in the Chinese market among foreign and private enterprises has declined, and they hope the government will enhance the transparency of policy information and provide clear policy interpretations. Some have pointed out that the development of foreign investment in China is not adequately portrayed in Western countries, where the narrative received is often negative, focusing on issues such as the South Sea conflicts and human rights concerns. These issues attract attention in American society and influence public opinion, while the positions of the U.S. and China on these matters are entirely different, further narrowing the space for communication. Notably, "investor panic" among foreign investors is increasing, as they worry about inconsistencies between China’s macro policies and their specific implementation. There is concern that foreign investment policies may be misinterpreted, which could affect the confidence in investing in China.

Fourth, there is concern that the ambiguous concept of "national security" may have spillover effects. In recent years, both the U.S. and China have intensified their policies and enforcement in this area. The U.S. has led multiple rounds of sanctions against China under the banner of national security, which has attracted significant global attention. In response, China has also started to strengthen its own national security measures, leading to some discomfort among foreign investors. For instance, in April 2023, China has revised its anti-espionage law. Since then, there have been cases involving both Chinese and foreign enterprises suspected of espionage, and increased regulation of data outflow has created varying degrees of worry among foreign investors. They are concerned that if the concept of "national security" remains too vague, it may be difficult for them to understand the relevant boundaries, potentially affecting their investment decisions in China.

Fifth, rising operational costs in China have led many foreign-invested enterprises to reassess the Chinese market. Under the influence of these various factors, the cost of operating in China has significantly increased. Previously, foreign enterprises focused primarily on developing their core businesses in the Chinese market. However, with the introduction of new policies, they now have to pay more attention to the potential impacts of these policies on their operations. Currently, foreign investors must consider not only market-level factors but also assist their internal and external partners in identifying and managing various risks, including national and market risks. Sometimes, even routine investment and market activities can incur additional operational costs due to the need to mitigate multiple risks. Some foreign companies have indicated that when the risk-return balance in the Chinese market becomes unfavorable, it affects their future outlook and forces them to adjust their investment strategies. As operational costs rise and uncertainties increase, foreign enterprises' confidence in continuing to expand their business in China has weakened, making it necessary for them to reassess the value and strategy of their investments in China.

It is important to note that while many foreign investors oppose the West from decoupling and excessive politicization, they are still compelled to adjust their strategies for the Chinese market due to worsening geopolitical conditions. They need to reassess the investment climate and security in China and prepare for potential extreme scenarios. As a result of these factors, foreign investors' concerns about the Chinese market are deepening and taking on a "structural" nature, with some industries and sectors potentially facing large-scale withdrawals. Foreign investors can be categorized into three groups: those who will leave if possible, including many with significant scale; those who will stay if unable to leave, such as large contract manufacturers; and those whose departure could lead to market collapse and self-destruction, like HSBC and Volkswagen.

China is currently under growing pressure to sustain its appeal to foreign investment. The outflow of foreign capital is driven more by the global market environment and structural factors than by individual companies. Consequently, the Chinese government needs to acknowledge this reality and strengthen its support for foreign investment through comprehensive policy measures. Rather than focusing solely on targeted interventions for specific foreign enterprises, it should aim to improve the overall business environment on a macro level. Therefore, it is crucial for the country to focus on structural issues and avoid the pitfalls of merely addressing symptoms rather than root causes.

Final analysis conclusion:

The external economic environment China faces is expected to continue deteriorating for a considerable period. Under these circumstances, its ability to participate in and advance international economic cycles will become significantly more challenging. Therefore, stabilizing and attracting foreign investment is a critical strategic task for the country. It is essential for China to adhere to proven policies, enhance communication with foreign investors, and leverage foreign investment to strengthen dialogue with the governments of other countries.

• Yang Xite is a Research Fellow at ANBOUND, an independent think tank.