New Characteristics and Trends in China's Foreign Direct Investment (FDI)
In recent years, particularly post-pandemic, China's landscape of Foreign Direct Investment (FDI) has undergone significant shifts. This article examines these changes through the lenses of growth trends, sources of capital, investment methods, and industry distribution.
Growth trends have seen a transformation from a stable, slight increase pre-pandemic to a substantial influx post-pandemic, with current indicators showing a high position retreating, facing certain pressures in growth performance. In terms of capital sources, there's been a notable increase in the proportion of funds from offshore financial centers, such as Hong Kong, with the associated phenomenon of "round-trip investment" gaining more attention.
Investment methods have also evolved, with Greenfield Investments in China facing more pressure compared to cross-border M&A channels. This shift in global investment patterns reflects an increase in foreign capital concentration, a matter of concern. Despite some recovery in manufacturing FDI in the past two years, the service and high-tech industries have maintained a rising trend in their proportion of FDI for many years, related to changes in China's industrial structure, policy openness, and the trend of "de-globalization" in manufacturing.
From January to May 2024, China's FDI recorded a year-on-year decrease, influenced by a certain base number. According to the Ministry of Commerce, the actual amount of FDI used cumulatively reached 412.51 billion yuan, a 28.2% decrease from the previous year. This decrease reflects a base number reason, as the FDI from the previous year set a historical high. Compared to the same period in 2019, there is still an 11.8% increase. However, looking only at May of this year, FDI recorded 52.31 billion yuan, the lowest since July 2018, with a year-on-year decrease of 30.6%, although the decline has narrowed compared to March and April.
The State Administration of Foreign Exchange also reflects the pressure of declining foreign investment in 2022-2023, but the pressure has eased since the fourth quarter of 2023. Due to differences in data caliber, statistical cycles, and data processing methods, there is a certain deviation between the FDI data of the State Administration of Foreign Exchange and the Ministry of Commerce, but the trend is similar. From the perspective of international balance of payments, the financial account data of the State Administration of Foreign Exchange shows that China's direct investment under the financial account has maintained a high level from the second half of 2020 to the first quarter of 2022. However, it basically returned to zero in the second quarter of 2022, turned negative in the third quarter of 2022, and continued to the fourth quarter of 2023, with six consecutive quarters of negative growth. The pressure of direct investment decline may be higher than in 2015-2016.
Looking at the trend in recent years, China's total FDI has grown significantly since the pandemic. According to the Ministry of Commerce, from 2013 to 2019, China's FDI maintained a stable and slight growth, with an average annual increase of about 3%. After the pandemic, China's FDI has grown substantially. From 2020 to 2022, China's FDI recorded 144.37 billion, 173.48 billion, and 189.13 billion US dollars, respectively, with a year-on-year increase of 4.5%, 20.2%, and 9.0%, respectively, setting historical highs for three consecutive years, with an average of three years 22.3% higher than in 2019.
Compared with the global situation, China's FDI year-on-year decline in 2023 was higher than that of other developing economies, but the overall performance from 2020 to 2023 was still better than that of other developing economies and even better than the global performance. In 2020, the outbreak of the global pandemic largely hindered foreign investment activities, and the global FDI flow contracted significantly, while China was the first to control the pandemic globally, with a complete and smooth industrial chain, attracting foreign capital to flow in quickly. According to the United Nations Conference on Trade and Development (UNCTAD), in 2020, China's FDI flow increased by 6% year-on-year, while the global FDI flow shrank by 35% during the same period. From 2021 to 2022, as most parts of the global economy gradually reopened, foreign investment showed a recovery growth. During this process, the growth of FDI in developing economies was significantly better than that in developed economies. In 2023, the global FDI performance further moved towards "normalization", the recovery growth of developing economies in the early stage has subsided, and the performance of developed economies was better than that of developing economies, with most economies experiencing a year-on-year decline in FDI. However, looking at the overall situation from 2020 to 2023, the global FDI level in 2020-2023 was 23% lower than in 2019, with developed economies falling by 52% and developing economies growing against the trend by 18%. Mainland China and Hong Kong, China, increased by 21% and 69% respectively, and other developing economies excluding the two increased by 10%.
Sources of Capital: Predominantly Offshore Financial Centers
China's FDI sources are heavily concentrated in offshore financial centers, with Hong Kong accounting for over seventy percent of the total inflows. According to data from the Ministry of Commerce, as of 2022, the primary sources of China's FDI were Hong Kong (73%), Singapore (6%), the British Virgin Islands (4%), South Korea (3%), and Japan (2%). From 2014 to 2022, an average of 70% of Mainland China's FDI originated from Hong Kong, with this figure rising to 73%, 76%, and 73% for the years 2020 to 2022, respectively, surpassing pre-pandemic levels.
The proportion of FDI directly from the six major offshore financial centers—Hong Kong, Singapore, the British Virgin Islands, the Cayman Islands, Macau, and Bermuda—averaged 83% during 2014-2022. This percentage increased to 86%, 88%, and 84% for the years 2020 to 2022, respectively, indicating a growing reliance on these financial hubs for FDI inflows.
During 2020-2022, the increment in China's FDI was almost entirely from offshore financial centers, with other sources still recovering. In 2021, FDI from Hong Kong reached $131.8 billion, an increase of $26 billion (25%) from the previous year. Over the same period, Mainland China's total FDI increased by $29.1 billion (20%). The annual average of China's FDI from 2020 to 2022 was $169 billion, an increase of $30.9 billion (22%) from 2019, with funds from Hong Kong averaging $124.9 billion, an increase of $28.6 billion (30%) from 2019. The funds from the six offshore financial centers averaged $144.9 billion, an increase of $31.2 billion (27%) from 2019. In contrast, funds excluding offshore financial centers only averaged $24.1 billion, a slight decrease of $0.4 billion (2%) from 2019. In 2022 alone, the year-on-year growth rate of funds from Hong Kong and the six offshore financial centers fell to 4%, while non-offshore financial center funds saw a significant increase of 43%, indicating a recovery trend.
It is noteworthy that FDI from offshore financial centers may include "round-trip investment." Globally, it is not uncommon for FDI funds to flow into various countries through offshore financial centers. These centers often act as bridges in global FDI due to their lower tax rates and financing costs, with the actual sources and destinations of investment typically being countries or regions with tangible business operations. If the FDI flowing into China ultimately comes from overseas economies such as Europe, America, Japan, and South Korea, and merely passes through "offshore financial centers" into the mainland, then this part of the funds still has "gold content." However, some of the FDI from "offshore financial centers" may come from "round-trip investments" within Mainland China itself. According to the definition by the State Administration of Foreign Exchange, "round-trip investment" refers to the direct or indirect investment activities conducted within the territory by domestic residents through Special Purpose Entities (SPEs), that is, establishing foreign-invested enterprises or projects within the territory through new establishments, mergers and acquisitions, and obtaining rights and interests such as ownership, control, and operational management. Under this investment form, funds will flow out of Mainland China in the form of OFDI (Outward Foreign Direct Investment) and then flow back to Mainland China in the form of IFDI (Inward Foreign Direct Investment), and are subsequently counted as part of FDI.
Mainland enterprises utilize offshore financial centers for "round-trip investment" primarily for two purposes: tax avoidance and capital appreciation. Some Mainland enterprises reduce their tax burden and transfer profits through offshore financial centers, then return to Mainland China in the form of IFDI to enjoy preferential treatment for "foreign capital." For instance, the bilateral preferential tax rate between Mainland China and Hong Kong is 5%, lower than the 10% tax rate applied to other regions. Capital appreciation is another motive, as Mainland enterprises establish SPEs in offshore financial centers to enjoy the additional benefit of facilitating overseas listings. Data indicates that since 2008, the annual FDI amount from Hong Kong has been in sync with the total market value of Chinese enterprises listed on the Hong Kong Main Board. Subsidiaries listed in Hong Kong may channel the financed funds back to the parent company in the form of IFDI, achieving "capital appreciation." Currently, the round-trip investment for overseas listings in China mainly involves private enterprises in the internet industry, which typically construct a VIE (Variable Interest Entities) structure.
Investment Methods: Resurgence of Greenfield Investments
Post the COVID-19 pandemic, global Greenfield investment activities initially faced challenges but have shown a consecutive three-year growth from 2021 to 2023. In contrast, cross-border M&A activities, which initially showed resilience, have since struggled, with a decline observed in the years 2022-2023. The primary modes of FDI entry are categorized into Greenfield Investments and cross-border M&A. Greenfield Investments involve establishing a new subsidiary from the ground up, while M&A involves purchasing part or all of an existing company's equity. Additionally, other forms such as international financing by multinational corporations and reinvestment of profits may also be included.
UNCTAD has separately compiled data for Greenfield investments and cross-border M&A across global regions. The data indicates that during 2020-2022, global Greenfield investment activities were initially under pressure, with both the amount and number of projects averaging a 6% and 22% decrease from 2019 levels, respectively. Cross-border M&A activities, however, maintained resilience, with an average 9% and 6% increase in transaction value and case numbers, respectively, compared to 2019. In 2023, global Greenfield investments saw further growth, with a 5% and 2% year-on-year increase in transaction value and project numbers, respectively. Conversely, cross-border M&A experienced a significant downturn, with transaction value and case numbers declining by 46% and 13%, respectively.
The resurgence of global Greenfield investments post the 2020 pandemic was influenced by several factors. Initially, Greenfield investments were hit hard by the pandemic, considering the complexity of new investment projects that typically require on-site inspections and cross-border movement of personnel and equipment. Prior to the pandemic, global Greenfield investments were already on a downward trend. UNCTAD noted in its 2017 "Global Investment Trends Monitor" that the growth in Greenfield investment value was only 5% in 2016, driven mainly by a few mega-projects in a minority of countries, while the inflow of Greenfield FDI in most countries had declined, reflecting investors' waning confidence in industry and global value chains.
Furthermore, the performance of manufacturing investments significantly impacts Greenfield investment performance. According to UNCTAD data, from 2020-2023, the manufacturing sector accounted for an average of 42% of Greenfield investments, while it only made up 28% of cross-border M&A. The absolute level of manufacturing Greenfield investments has consistently exceeded that of cross-border M&A since 2017, with the gap widening annually from 2021-2023. The global manufacturing FDI saw a significant contraction from 2019-2022 but rebounded sharply in 2023, growing by 27% year-on-year. This recovery may be linked to the global push for industrial chain reshaping and the implementation of "reindustrialization" strategies.
Lastly, global tax reforms may affect the willingness of Greenfield investments. In recent years, the issue of base erosion and profit shifting in cross-border investments has been a global concern. Since 2020, the "global minimum tax rate" initiative has accelerated, and the impending global tax reform has created expectations of rising cross-border investment costs, further limiting the willingness for Greenfield investments post-2020.
Industry Distribution: Continued Rise in Service and High-Tech Shares
Since 2023, China's manufacturing FDI has seen a smaller year-on-year decline compared to the service industry, with the high-tech sector emerging as a primary driver. According to data from the Ministry of Commerce, in 2023, China's manufacturing FDI recorded 317.92 billion yuan, a 1.8% decrease, accounting for 28.0% of the total FDI; within this, high-tech manufacturing FDI grew by 6.5%, with the medical equipment and instrumentation manufacturing industry, and the electronics and communication equipment manufacturing industry experiencing increases of 32.1% and 12.2%, respectively. Meanwhile, the service industry FDI recorded 776.08 billion yuan, a 13.4% decrease, representing 68.4% of the total FDI.
The combined FDI in high-tech industries (including both manufacturing and services) reached 423.34 billion yuan, accounting for 37.3% of the total FDI, an increase of 1.2 percentage points from 2022, setting a historical high. From January to May of the current year, China's manufacturing FDI accumulated to 117.11 billion yuan, representing 28.4% of the total FDI, with high-tech manufacturing accounting for 50.41 billion yuan, or 12.2% of the total FDI. Both manufacturing and high-tech manufacturing's share of FDI has increased by 2.8 and 2.7 percentage points, respectively, compared to the same period of the previous year.
Looking at recent trends, the focus of foreign investment in China has shifted from manufacturing and real estate to the service and high-tech industries. Historical data from the Ministry of Commerce shows that FDI was primarily directed towards manufacturing and real estate, peaking at 52.1 billion USD for manufacturing in 2011 and 34.6 billion USD for real estate in 2014. However, by 2019, FDI in both sectors had dropped to 68% of their historical peaks. From 2020 to 2022, the average annual FDI value for real estate further declined to 56% of its peak value, while manufacturing FDI recovered to 73% of its peak. The combined share of FDI in manufacturing and real estate has gradually decreased from over 70% before 2010 to 33-36% from 2020 to 2022. In contrast, the FDI share in services and high-tech industries has steadily increased, with six sectors including transportation, finance, wholesale and retail, TMT (Technology, Media, and Telecommunications), scientific research, and business services rising from less than 20% before 2010 to 58-60% from 2020 to 2022.
The shift in FDI focus from manufacturing to services can be understood in the context of domestic industrial structure changes. The decline in manufacturing FDI correlates with changes in the domestic industrial structure, reflecting the upgrading of the manufacturing industry and the trend of servitzation. Between 2004 and 2011, the share of manufacturing value-added in GDP entered a plateau phase, followed by a continuous downward trend from 2011 to 2020. With the adjustment of China's industrial structure, the growth rate of FDI in the manufacturing sector has also correspondingly declined.
Furthermore, the acceleration of service industry FDI inflows has benefited from the increased openness of China's policies. Since 2017, China has been expanding its openness to foreign investment in the service sector, leading to a structured decrease in the Foreign Investment Restrictiveness Index. According to OECD statistics, China's index for the tertiary industry (services) significantly decreased from 0.506 in 2011 to 0.254 in 2020, with the most notable declines in financial services, transportation, and wholesale and retail trade.
Additionally, in the context of global industrial chain restructuring, foreign investors have become more cautious about investing in overseas manufacturing. On one hand, as China's economy continues to develop and the population growth rate slows, the comparative advantage of labor costs is gradually diminishing. The application of new information technologies such as industrial robots and the industrial internet has significantly reduced the comparative advantage of labor costs. Conversely, proximity to the end market has become an important consideration for multinational companies. On the other hand, against the backdrop of "deglobalization," developed economies have shown an increased desire for manufacturing to return home. Since the Sino-American trade frictions in 2018, China's manufacturing FDI growth rate and its share have noticeably declined after 2019.
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Source: https://opinion.caixin.com/
Post time: Aug-14-2024