China’s foreign direct investment flows

Many commentators are saying that the rest of the world will now seek to reduce its connections to China, but the data tells a different story, Chunlai Chen and Christopher Findlay write.

Total foreign direct investment (FDI) into China in 2019 was $137 billion, increasing 5.8 per cent over 2018. In the COVID-19 context, there has been a 13 per cent decline in FDI in China over the period January to March 2020. However, there was rapid growth in April, when FDI reached $10.14 billion, rising by 8.6 per cent compared to the same month a year earlier. This is a clear indicator that inbound FDI is recovering in China.

FDI will not drive the overall post-COVID-19 recovery in China, as the share of FDI inflow was only 1.74 per cent of total investment in fixed assets in 2019, but it is a positive part of the process, and it is particularly important for employment in some areas, and also crucial for technology inflows.

This recovery in FDI inflows is of interest for another reason: it challenges the view that businesses will withdraw from China in the wake of the pandemic. In fact, it shows that many will be striving to maintain their business operations in China.

China’s attractiveness for investment comes down to its huge market size, low – though rising – labour costs, and good transportation and telecommunication infrastructure.

China has also implemented new FDI laws which will improve the market access and provide more investment opportunities for foreign investors. According to one law firm’s assessment, the new law and regulations mark a new era for foreign investment in the country.

The Financial Times has also been positive about the new laws. It refers to the importance of the commitment to a number of changes, including a commitment to ‘national treatment’, that is, affording foreign investors rights equivalent to those enjoyed by domestic firms.

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It also noted that intellectual property rights of foreign businesses are now protected in the same way as Chinese firms, that government agencies are prohibited from divulging foreign enterprises’ trade secrets, and that foreign investors have been given the freedom for overseas remittance of profits, capital gains and liquidation proceeds, both in renminbi or in foreign currency.

Importantly, under the new regulations access to Chinese government procurement tenders has been allowed to foreign firms, and when expropriation does occur, ‘fair and reasonable’ compensation ‘shall be given in a timely manner’.

There are also important changes in the pattern of which countries are spending on FDI into China, some of which are linked to changes in trade flows.

First, it looks like there is strong interest in investment from Belt and Road Initiative (BRI) countries into China, and investment from BRI countries went up by 7.9 per cent in the first four months of 2020.

Investment from ASEAN countries into China also increased by 13 per cent in the first four months of 2020, following trade and investment liberalisation via the China-ASEAN free trade agreement, which was upgraded in 2015.

In tandem with this, the first three months of 2020, ASEAN-China trade increased by six per cent year-on-year, accounting for 15 per cent of China’s total trade volume. ASEAN has displaced the European Union as China’s lead trading partner, in part as a result of Europe’s pandemic lockdown.

China is in fact now a net importer of integrated circuits from ASEAN, as Japan and Korean companies relocate manufacturing there from China. ASEAN also imports components from China, which illustrates the complexity of the production networks in the region.

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A negative factor in FDI inflows is the trade war with the United States, which will impede American investment into China that depends on selling back to the US, because of the fear of tariffs on the exports .

At the same time though, FDI Law was changed in ways which align with American requests and often the local market is of greater interest to many investors. Overall, US FDI into China has been maintained in 2019, compared to 2018.

For example, Tesla invested $5 billion in Shanghai to build an electric car factory in 2019, but not primarily for exports – China is Tesla’s second biggest market after the US.

The FDI inflow is also concentrated in particular services sectors, some of which are intensive in high technology. In part, this may be an anticipation of the response to COVID-19, reinforcing trends to ecommerce and to doing business online.

Also, the OECD points to China as a ‘leading’ services reformer in the period 2014 to 2019. Some changes identified included a number of reforms which opened up many parts of the services sector, plus the use of online notification systems for new projects for approval, easier standards for fee setting of professional services, relaxing nationality requirements for directors of accounting firms, and new cybersecurity laws.

Australia’s share of FDI into China is relatively small at around 0.2 per cent, but these policy changes create opportunities for the Australian services sector in China.

In the other direction, China’s outgoing FDI has been declining since 2017. China’s outward FDI flow was $118 billion in 2019, which was a decline of 6 per cent from 2018. This dropped again in the first quarter of 2020 by 3.9 per cent compared to the same time a year earlier. But outward FDI was $4.3 billion into BRI countries, increasing 11.7 per cent. The trade relations between China and BRI countries have intensified in both directions, which is likely linked with changes in FDI flows.

One factor in this decline in the outward flow is that China has tightened control since 2017 to improve its FDI structure, screening outflows and putting limits on some sectors, including entertainment, and preventing blind investment projects overseas. There is also an effort to contain illegal capital flight masquerading as investment.

This context is important for Australia, for whom China accounts for between three and six per cent of total inflow to Australia and only two percent of the foreign-owned capital stock. China is Australia’s most important trading partner, but ranks much lower – in ninth place – as a source of capital inflow.

According to data from Chinese sources, FDI to Australia was relatively high in 2016 and 2017 and of the order of $4 billion, but this halved in 2018.

Recent reports are that Chinese FDI in Australia fell again, by over 60 per cent, in 2019 compared to 2018, greater than the fall in other countries.

This reflects both the Chinese government’s greater control of capital outflows as well as the Australian government’s concerns about the impact of Chinese investments, especially by state-owned firms. However, the FDI inflow is now dominated by private investors. It appears state-owned enterprises are more likely direct their investment towards BRI countries.

Other economies are apparently maintaining their connectivity with China, in investment and trade. Australia’s long-term interests also depend on integration with China. There are new opportunities for Australia to invest in China, especially in services.

However, sustained connectivity depends on two-way movements. Recent Australian decisions will, we expect, impede the inbound flows. One is the more extensive screening regime imposed in response to COVID-19 and another is a plan for further tightening related to security objectives. Both of these items are worth revisiting, especially in the context of such significant changes in Chinese policy and practice.