Regional analysis

China | Should we worry about the falling FDI?

Jinyue Dong and Le Xia
January 10, 2023

Chinese FDI recently dipped to its historical low, attracting wide market concerns. In particular, based on the
Balance of Payment (BoP) data provided by State Administration of Foreign Exchange (SAFE), the net FDI inf low
f ell to USD -11.8 billion in Q3 2023, registering a negative outturn f or the f irst time over the past decades. (Figure
1)

The recent drop happened on the backdrop of China’s escalating geopolitical risks, domestic housing market crash
and more importantly, disappointing growth recovery in the af termath of the nationwide Covid -19 lockdown. (Figure
2)

In this report, we f ocus on analyzing the f ollowing important questions regarding the recent FDI drop in China: (i)
How serious is the situation based on dif ferent measures provided by SAFE and Ministry of Commerce? (ii) What
are the driving f orces behind the sharp drop of China’s FDI? Are they cyclical or structural f actors? (iii) To what
extent does the FDI drop (or the shortage of it) inf luence China’s economy under current circumstances? (iv) What
measures should the Chinese authorities take to lure them back in the f uture?

Understanding the recent FDI drop with two different measurements: SAFE
and Ministry of Commerce
There are two dif f erent indicators that gauge the FDI inf lows to China: one is based on Balance Sheet Payment
(BoP) data provided by the SAFE (State Administration of Foreign Exchange) while the other is based on the data
provided by MOFCOM (Ministry of Commerce). Nowadays, these two indicators dif fer a lot.

The FDI reported by MOFCOM is declining but doesn’t seem to be that worrisome. Its year-on-year growth is
around -10% in the f irst three quarters of 2023, which is comparable to its perf ormance in 2020 (Covid-19
pandemic), 2017 (China's deleveraging) and 1999 (Asian f inancial crisis). During the 2008 Global Financial Crisis
this indicator dipped by more than -30% y/y. (Figure 3)

However, the FDI indicator reported by the SAFE (Figure 4) shows a dramatic change of -200% y/y over the same
period. Such drop is the largest in the past several decades.

The PIIE report by Nicholas R. Lardy (2023) provides a clear and comprehensive exp lanation f or the dif ferences
between the data reported by the SAFE and the MOFCOM. These dif f erences include:

1. IPOs in offshore markets: SAFE accounts for IPOs in offshore markets, whereas MOFCOM does not include
them in their data.
2. Foreign venture capital and private equity investment (VC/PE): SAFE counts VC/PE investments, while
MOFCOM does not consider them in their calculations.
3. Reinvested profits and repatriated profits: SAFE includes reinvested profits of foreign firms as inflows of FDI,
whereas MOFCOM does not count reinvested profits as FDI inflows. Additionally, repatriated profits of foreign firms
operating in China are considered FDI outflows by SAFE but not by MOFCOM.
4. Direct investments in the financial sector: Foreign financial institutions' direct investments in China's financial
sector are counted by SAFE but not by MOFCOM.

China | Should we worry about the falling FDI? / January 10, 2024 1
5. Related foreign firms' bank borrowing: SAFE includes the bank borrowing of related foreign firms (mostly in USD
and from foreign banks) to invest in China's branches. For example, Tesla's headquarters borrowing from US
banks to invest in China's Tesla branch. This factor is not accounted for by MOFCOM.

Figure 1. BASED ON CHINA’S BALANCE OF Figure 2. THE RECENT FDI INFLOW DIPPING GOES
PAYMENTS, FDI NET INFLOW DIPPED TO -11.8 HAND IN HAND WITH GROWTH SLOWDOWN AND
BILLION IN Q3, FIRST NEGATIVE IN PAST YEARS WEAK SENTIMENTS

USD mn
%
120000.000
17
100000.000
12
80000.000 7
60000.000 2
40000.000 -3
-8
20000.000

Mar-18

Mar-19

Mar-20

Mar-21

Mar-22

Mar-23
Sep-17

Sep-18

Sep-19

Sep-20

Sep-21

Sep-22

Sep-23
0.000
-20000.000
09/2005
09/2006
09/2007
09/2008
09/2009
09/2010
09/2011
09/2012
09/2013
09/2014
09/2015
09/2016
09/2017
09/2018
09/2019
09/2020
09/2021
09/2022
09/2023

Final Consumption Expenditure

Gross Capital Formation
Net Export of Goods and Service
BoP: Financial Account: Direct Investment: Liabilities GDP growth

Source: CEIC and BBVA Research Source: BBVA Research, CEIC

Figure 3. BASED ON MOFCOM, THE CURRENT DROP

Figure 4. BUT BASED ON SAFE FIGURE, FDI DIP HAS
IS EQUIVALENT TO THE DROP IN 2020, 2017 AND
BEEN THE WORST IN THE PAST DECADES
1998 BUT SMALLER THAN 2008 GFC

120.0% y/y%
100.0% 250
80.0% 200
150
60.0% 100
40.0% 50
0
20.0%
-50
0.0% -100
-150
-20.0%
-200
-40.0% -250
1/1998
7/1999
1/2001
7/2002
1/2004
7/2005
1/2007
7/2008
1/2010
7/2011
1/2013
7/2014
1/2016
7/2017
1/2019
7/2020
1/2022
7/2023

9/1999
9/2000
9/2001
9/2002
9/2003
9/2004
9/2005
9/2006
9/2007
9/2008
9/2009
9/2010
9/2011
9/2012
9/2013
9/2014
9/2015
9/2016
9/2017
9/2018
9/2019
9/2020
9/2021
9/2022
9/2023

Source: Ministry of Commerce, CEIC and BBVA Research Source: BBVA Research, CEIC and SAFE

Furthermore, it is noteworthy that the decline in Chinese FDI aligns with the global FDI drop. According to UNCTAD
data, global FDI also signif icantly declined by -12% to a level of USD 1.3 trillion in 2022. This decline can be
attributed to f actors such as rising f unding costs (high USD interest rates), geopolitical tensions, and decelerating
global FDI returns etc.

China | Should we worry about the falling FDI? / January 10, 2024 2
Is the ongoing FDI drop structural or cyclical?
We can identif y both structural and cyclical f actors that contribute to the ongoing signif icant deceleration of FDI
inf lows to China. Let us start with those cyclical ones:

First, due to the disappointing growth recovery in 2023, the industrial prof its have f allen signif icantly. As a result,
the f alling industrial prof its of foreign f irms lead to their sharp decline in retained reinvested prof its, which are
counted as FDI by the SAFE. (Figure 5)

Figure 6. FDI INFLOWS TO TECHNOLOGY SECTOR

Figure 5. INDUSTRIAL PROFITS REMAINED NEGATIVE
MODERATED SIGNIFICANTLY AFTER TRUMP’S
SINCE 2022 AMID ECONOMIC SLOWDOWN
TECH WAR WITH CHINA

%, y/y % y/y
200
200.0
180.0
160.0 150
140.0
120.0 100
100.0
80.0
60.0 50
40.0
20.0 0
0.0
-20.0
-40.0 -50
-60.0
01/2001
06/2002
11/2003
04/2005
09/2006
02/2008
07/2009
12/2010
05/2012
10/2013
03/2015
08/2016
01/2018
06/2019
11/2020
04/2022
09/2023

-100
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
Industrial profits growth

Source: WIND and BBVA Research Source: BBVA Research and CEIC

Second, the high f unding costs of US dollar, thanks to the Fed’s f ast interest rate hikes during 2022-2023, have a
signif icantly negative impact on the PE/VC inf lows to China. Meanwhile, multinational f irms are reluctant to inject
more money into their branches in China due to the elevated f inancing costs as they usually borrow f rom the bank
in parent company by USD. On the contrary, some f oreign companies take advantage of China’s relatively cheaper
f unds (Figure 7) and borrow working cap ital in China f or the use of their overseas operations.

Third, “round-tripping” FDI also matters. Round-tripping FDI ref ers to the domestic capital that has f led the home
country and then f lows back in the f orm of FDI. The round-tripping FDI in China is sizable. People believe that the
round-tripping FDI accounts f or 20-50% of total FDI based on dif f erent methodology of estimation. If the purpose of
this round-tripping FDI is to take advantage of cheaper f unds f rom overseas, it is no wonder that this part of FDI
collapsed in 2023 due to the rising overseas f unding costs amid US interest rate hike. In ad dition, China has
strengthened their f inancial regulations on this kind of potential round-tripping FDI in a bid to circumvent these f irms
to take advantage of China’s f avorable policies to f oreign FDI.

On top of the above cyclical f actors, a number of structural f actors also contribute to the recent large FDI decline.

China | Should we worry about the falling FDI? / January 10, 2024 3
 Figure 7. CHINA-US INTEREST RATE REVERSION Figure 8. CHINA’S LABOR COST HAS BEEN RISING,
ALSO MAKES USD FUNDING COST HIGHER LEADING TO VALUE CHAIN RELOCATION
%
RMB
8
100000
7
90000
6
80000
5
70000
4 60000
3 50000
2 40000
1 30000
0 20000
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10

Dec-12
Dec-13
Dec-14
Dec-15

Dec-17
Dec-18
Dec-19
Dec-20
Dec-21
Dec-22
Dec-23
Dec-11

Dec-16

10000
0

US Federal Funds Effective Rate-30 days

China's policy rate CN: Average Wage

Source: CEIC and BBVA Research Source: CEIC and BBVA Research

First, the primary structural f actor is the global value chain relocation away f rom China, caused by “decoupling” or
“de-risking” policy adopted by the US and its allies. At the same time China’s rising labor costs (Figure 8) also
contribute to supply chain relocation. (see our previous China Economic Watch: China | De-Sinicization of Global
Value Chain af ter Covid-19, and China | Which economies are to benef it f rom industry relocation?)

Second, due to the regulatory storms in China in 2021 and the US restrictions on technology investment to China,
PE/VC investment in China’s technology sector has decelerated very f ast recently. The sharp drop of PE/VC
investment in Chinese technology sector contributes signif icantly to SAFE source of FDI drop (as MOFCOM does
not count this part).

For instance, in August 2023, the US President Biden signed the screening mechanism of f oreign direct
investment, restricting the US entities to invest in China’s semiconductor, AI and quantum inf ormation technology
etc. The similar investment restrictions were implemented in Japan too. Beyond that, the Japanese government
during the Covid-19 pandemic time provided subsidies to encourage Japanese f irms to relocate their global value
chains back to Japan.

Some more recent surveys conducted by Japanese Chamber of Commerce and the US Chamber of Commerce
also illustrate that the f oreign companies hesitate to invest in China amid rising US-China tensions. For instance, in
a September 2023 survey of member companies by the Japanese Chamber of Commerce and Industry in China,
nearly half of respondents said they would not invest in China at all in 2023 or invest less than in 2022. Escalating
tensions with the U.S. are one reason f or the decline in f oreig n investment. In a survey taken last f all by the
American Chamber of Commerce in China, 66% of member respondents cited rising bilateral tensions as a
business challenge in China.

Another direct evidence is that the share of the US FDI to China has moderated signif icantly af ter the start of
Trump Administration. (Figure 9)

Third, another structural f actor is that China might not need as much FDI as bef ore in China’s new economic
development stage.

China | Should we worry about the falling FDI? / January 10, 2024 4
Figure 10 illustrates this point. By analyzing the FDI inf lows f or main emerging economies, we f ind that countries
such as India, Vietnam, Mexico, Indonesia etc. that are trying to copy “China model” in 2000s all recorded rising
FDI inf lows. By contrast, China’s FDI inf lows have been declining over time in the past years. (Figure 10) Together
with China’s development model transf ormation f rom export-oriented and processing trade-oriented economy to
consumption and high-end manuf acturing-oriented economy, China might not need as much as FDI inf lows as
bef ore back to 1990s and 2000s. (We will f urther discuss this issue in the next session)

The above structural f actors are likely to persist in the f oreseeable f uture. That being said, we believe China’s FDI
inf lows won’t bounce back to their level of 1990s and 2000s even if those cyclical f actors turn f avorable again.

Is it a big issue given that China has become an international creditor?

Countries’ demand f or FDI inf lows vary with their dif ferent economic development stages. China has become a net
creditor in the world since 2000s. It will naturally beg the question whether China needs FDI as much as bef ore.
(Figure 10)

Figure 9. THE SHARE OF US FDI TO CHINA DECLINED Figure 10. CHINA MIGHT NOT NEED AS MUCH FDI AS
SIGNIFICANTLY SINCE TRUMP’S ADMINISTRATION BEFORE IN THE NEW DEVELOPMENT STAGE

100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
1991
1995
1999
2003
2007
2011
2015
2019

Asia: Macau SAR (China) Europe: United Kingdom

Asia: Singapore North America: United States
Europe: Netherlands Asia: South Korea
Europe: Germany Asia: Japan

Source: CEIC and BBVA Research Source: Rhodium Group, UNCTAD world investment report 2023

According to the Development Economy theory, when a country migrates f rom a low-income economy to a middle-
to-high income (or high income) economy, usually it lacks capital but has natural endowments of labor and
resources. During the transf ormation period, they need more FDI inf lows so as to combine with the domestic cheap
labor and resources to pursue economic growth. However, when a country becomes a middle-to-high- or high-
income economy, its labor cost will go up signif icantly while they should have already accumulated abundant
capital f or investment. At this stage, it does not need as much FDI inf lows as bef ore. (Figure 11)

China’s growth trajectory is consistent with this economic development theory. In the past ten years f rom 2013 to
2022, the ratio of FDI inf lows to China’s total GDP has been declining f rom 3% to 1%; and the net FDI position (the
stock) to GDP ratio also declined f rom 24% to 19%. (Figure 12) Given China’s stunning economic perf ormance in

China | Should we worry about the falling FDI? / January 10, 2024 5
2013-2022, during which FDI inf lows has experienced gradual slowdown, it indicates that the role of FDI inf lows
might not be as important as in the period f rom 1980s to 2000s.

Is foreign FDI inflow still important for Chinese economy?

However, even at China’s new economic development stage, the indirect ef f ect of FDI decline is much more
important and nuanced than its direct ef f ect as stated above.

In particular, FDI inf lows usually bring about technology advancement, “learning -by-doing” ef f ect, advanced
management methods, international standards and more crucially, the competition which lead to the increase of
total f actor productivity domestically.

The OECD paper (2000) comprehensively summarized the indirect ef f ects in China, including: (1) FDI – An
increasingly important source of capital; (2) FDI has created jobs; (3) FDI has upgraded skills; (4) FDI has paid
higher wages; (5) FDI has raised f actor productivity and increased technology transf er; (6) FDI has modif ied
China’s industrial structure; (7) FDI has increased domestic competition; (8) FDI has increased industrial
perf ormance.1

Figure 11. CHINA BECAME THE WORLD’S LARGEST Figure 12. IN THE PAST 10 YEARS, FDI INFLOWS
CREDITOR SINCE 2000S (ANNUAL BOP) ONLY COUNT FOR 1-3% OF CHINA’S TOTAL GDP

USDmn % %
500000 30.000 5.000
4.500
400000 25.000 4.000
300000
20.000 3.500
200000
3.000
100000 15.000 2.500
0 2.000
-100000 10.000 1.500
-200000 1.000
5.000
-300000 0.500
-400000 0.000 0.000
2005

2007

2009

2011

2013

2015

2017

2019

2021

-500000
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022

Foreign Direct Investment Position: Inward: % of GDP: Total

BoP: Net Errors and Omissions BoP: Financial Account (FA)
Foreign Direct Investment Financial Flows: Inward: % of
BoP: Current Account (CA) GDP: Total (RHS)

Source: CEIC and BBVA Research Source: CEIC and BBVA Research

For instance, Apple Inc.’s investment and large presence in China brings about f ierce competition among domestic
smart phone markets and thus f oster a series of domestic smart phone brands, such as Huawei, Xiaomi, and Vivo
etc. which recently become the rising stars in the global smart phone market. In addition, Tesla mega f actory in
Shanghai also brings about high technology and competition in domestic EV market which f osters domestic EV
brand such as BYD etc., that ultimately leads to China’s EV market going to the f rontier of the world.

1 Notes 1, OECD (2000), “Main Determinants and Impacts of Foreign Direct Investment on China's Economy”, OECD Working Papers on International Investment, 2000/04, OECD Publishing.
http://dx.doi.org/10.1787/321677880185.

China | Should we worry about the falling FDI? / January 10, 2024 6
Although China has experienced the global value chain relocation away f rom China in the labor-intensive low-end
sectors, such as textile, f ootwear, clothing, f urniture etc., China in the recent years still attracts FDI inf lows in high-
end manuf acturing sectors: chemical sector, auto making, EV, green energy, semiconductor, telecommunication
and pharmacy etc. This is def initely in line with the national strategy of developing “high-end manuf acturing” and
f ostering China to be the world’s “high-end manuf acturing” center in the world, f ollowing German model or Japan
model. That means, attracting FDI in high-end manuf acturing sector and taking use of its “learning-by-doing” and
technology spillover ef f ect is crucial in China’s new development stage.

What should Chinese government do to attract FDI inflows to high-end

manufacturing sectors?
Attracting f oreign direct investment (FDI) and guiding it into high-end manuf acturing sectors is a crucial policy
objective f or the Chinese government in the f uture. China’s authorities should take important lessons and open
their arms to f oreign investors.

First of all, Chinese government should persist the long-lasting “ref orm and opening up policy” and improve f oreign
investor’s sentiments to invest in China by promulgating more pref erential policies on f oreign FDI. These policies
not only include reducing negative list, providing more equal environment f or f oreign f irms with domestic f irms,
expanding market entry conditions, but also include providing “national treatment” principle f or f oreign f irms and
protecting IPR (intellectual property rights), etc.

Second, Chinese government needs to continue to support Chinese economic growth and to avoid systemic
f inancial risks, as the stable and prosperous domestic environment is the prerequisite of f oreign FDI inf lows. For
the historical experience, FDI inf lows have a synchronized relationship with domestic G DP growth, as more
prosperous growth outlook leads to larger corporate prof its , thus higher FDI investment returns and better f oreign
investor sentiments. In the f uture, Chinese government not only needs to secure the economic sof t -landing, but
also to contain domestic f inancial risks in real estate sector, local government debt as well as small f inancial
institutions’ def ault risk. A more robust domestic f inancial condition will also help to support f oreign investors ’
sentiments.

Third, Chinese government needs to stabilize China-US relationship as well as to deepen investment and trade
relationship with One Belt One Road (OBOR) and RCEP countries. Although the China-US’s long-term trade war,
technology war and f inance war will persist in the f uture, Chinese g overnment should never abandon their ef f ects
to stabilize its relation with the US. The most recent case is the Biden-Xi meeting during APAC meeting in San
Francisco at end-2023 which, to a certain extent, could help mitigate the conf licts. Regarding the trade and
investment relationship with OBOR and RCEP countries, China should expand its own allies to conf ront the
exclusion f rom the western allies regarding investment and trade linkages.

Last but not least, China’s authorities should become humbler if they want to lure f oreign investors back. The
authorities should caref ully listen to f oreign investors and help them to solve pain points in their investment. In
response to investors’ dampened conf idence and increasing concerns, the authorities should clearly deliver the
message to the world that they are still prioritize economic growth and social development.

China | Should we worry about the falling FDI? / January 10, 2024 7
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China | Should we worry about the falling FDI? / January 10, 2024 8