For many years, China's economic growth has been significantly fuelled by foreign direct investment (FDI), helping the nation quickly become the second-largest economy in the world. But FDI inflows have significantly decreased over the past year, recent data shows, raising questions about the future course of China's economy. If this downward trend continues, it could have implications for China's long-term economic stability, growth prospects, and its role in the global economy.
The decline in foreign investment
Official figures show that FDI in China saw a 29.6% decline year-on-year from January to July 2024, even as the number of new foreign-invested enterprises increased by 11.4% during the same period[1]. This decline in investment reflects growing concerns among investors regarding the Chinese market, potentially fuelled by geopolitical tensions, economic slowdowns, and structural shifts in China's economic model.
One key factor behind the decline in FDI is the shift in China's economic focus from traditional manufacturing to high-tech and innovation-driven industries. While this transition aligns with China’s long-term strategic goals, it has led to a reconfiguration of foreign investment patterns. Traditional sectors, such as low-end manufacturing, have seen reduced inflows, while high-tech sectors have attracted more capital, albeit not enough to offset the overall decline.
China is also facing the issue of an increasingly competitive global economic landscape, with countries like Vietnam and India emerging as attractive alternatives for low-end manufacturing due to their lower labour costs, younger demographics and favourable tax incentives. Meanwhile, developed economies such as the United States are drawing significant investment through their advanced financial markets and technological innovation. This shifting dynamic has increased the pressure on China to maintain its appeal as a compelling destination for foreign investment.
Additionally, a period of higher interest rates in the US and other major economies has meant that foreign businesses have pulled money out of China to chase higher yields elsewhere in the hope of higher returns. As a result, businesses and investors have reduced their risk exposure to China, where economic uncertainties have compounded a lack of interest.
However, the prevailing view is that the global rate-hiking cycle has reached its peak, especially following the US Federal Reserve’s 50 basis point cut earlier this month. This scenario could potentially lead to capital flows back into China, as investors chase better growth prospects and provide much-needed support for China’s slowing economy.
Implications for the Chinese economy and attempts to resolve the issue
The decline in foreign investment has significant implications for the Chinese economy. First and foremost, it could exacerbate the slowdown in economic growth. FDI has historically been a major source of capital, technology and expertise for China, contributing to the modernisation of its industrial base and the development of new sectors, particularly in high-tech industries. A reduction in FDI could slow the pace of technological innovation and industrial upgrading, making it harder for China to transition to a more advanced, services-oriented economy.
Moreover, the decline in FDI could weaken China’s position in global supply chains. As multinational companies diversify their supply chains away from China to mitigate risks, China could lose its status as the "world’s factory”. This could lead to job losses in key manufacturing sectors and reduce the country’s export revenues, further straining the economy.
However, China has introduced several policy measures aimed at improving the business environment for foreign investors. In 2024, the Chinese government updated its "Negative List" for foreign investment, which further opened up sectors like telecommunications, education, and healthcare, while also eliminating restrictions in the manufacturing sector. These changes are intended to attract advanced foreign technologies and stimulate domestic industry innovation, particularly in areas such as AI and green technologies.
Moreover, China has launched the "24 Measures" initiative – a new action plan that seeks to increase foreign capital in China by proposing a range of measures to benefit foreign companies[2]. These measures are designed to address longstanding concerns of foreign-invested enterprises (FIEs) and improve overall investor confidence.
However, the effectiveness of these reforms in reversing the decline in FDI remains uncertain. While these policy updates signal China's commitment to maintaining an open economy, restoring investor confidence will likely require more substantial and coordinated efforts. Persistent issues such as unequal treatment in public procurement and ongoing geopolitical uncertainties continue to dampen the overall investment climate.
Conclusion
The recent decline in foreign investment in China is a significant development that could have far-reaching consequences for the country’s economy. However, with interest rates slated to decline, this trend could see a slow down or reversal. Beijing also recognises the issue and has taken steps to encourage investment; if this is coupled with policy steps to improve economic growth and address the property crisis, we could see FDI pick up again. Indeed, just in the past few days the People’s Bank of China (PBOC) has announced a swathe of stimulus measures to support the economy.
While the current backdrop in China is throwing up some challenges, there are still valuable opportunities for investors prepared to be patient and to look further afield. This highlights the benefits of active management in terms of spotting those opportunities. Stocks are currently trading at very attractive valuations, and while some consumer data is underwhelming, there are encouraging areas of growth. Sectors like consumer services, travel, and tourism are performing well, with positive trends and strong momentum. There are also companies that are doing well to innovate in a competitive landscape, for example, appliances, and industries where China is a global leader, such as electric vehicles and the associated batteries, all of which present compelling long-term opportunities.
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