Taking time away from his tense meeting with President Joseph R. Biden Jr., President Xi Jinping spoke in San Francisco in mid-November to US corporate and big tech CEOs, assuring them that China is ready to be a partner and friend of the United States and that its modernization offers a “huge opportunity” for the world. Little wonder that he seeks to dial back tensions with the United States: New Chinese data imply that foreign firms operating in China are not only declining to reinvest their earnings but—for the first time ever—they are large net sellers of their existing investments to Chinese companies and repatriating the funds.
These outflows exceeded $100 billion in the first three quarters of 2023 and are likely to grow further based on trends to date. The investment selloffs are contributing to downward pressure on the value of the Chinese currency and, if sustained, will modestly reduce China’s potential growth.
Several factors appear to be influencing the trend, including the spike in US-China tensions, making investors more cautious. In addition, Beijing’s closure of foreign consultancy and due diligence firms that are critical to foreign firms’ evaluation of potential new investments and its increasingly stringent regulatory environment, including a new national security law and restrictions on cross-border data flows, have led foreign firms to reduce their direct investment or even to disinvest from their existing direct investments.
Time will tell whether President Xi’s words will first stem the current large foreign direct investment (FDI) outflows and eventually lead to a resumption of the net FDI inflows that China has enjoyed for more than four decades. A safe assumption is that it will take more than words to accomplish this objective.
The figure below shows two different official time series for inward FDI: one from the Ministry of Commerce (MOFCOM) and the other from the State Administration of Foreign Exchange (SAFE). There are multiple differences between the two series, but the main one is that SAFE measures FDI on a net basis, i.e., FDI inflows minus FDI outflows, while MOFCOM only measures gross FDI inflows. Both agencies include greenfield investment and mergers and acquisitions (M&A) by foreign firms in their FDI data while SAFE also includes several other items. While these additional items were large a few years ago, as explained below, they are now likely quite small. Most of the $113 billion difference between the two numbers in the first three quarters of 2023 must result from the net sale of direct investment assets by foreign investors.
As shown in the figure, through 2021 the SAFE measure of FDI inflows was larger than MOFCOM’s. There were several reasons for this disparity:
- Because of the peculiar legal structures involved, SAFE numbers include the value of initial public offerings (IPOs) of some Chinese companies in offshore markets. MOFCOM does not include these inflows.
- When foreign venture capital and private equity investment leads to a foreign ownership share in a Chinese startup of 10 percent or more, SAFE counts this as FDI. (If it is less than 10 percent, SAFE counts this as a portfolio inflow, per International Monetary Fund conventions.) MOFCOM ignores these transactions.
- SAFE counts on a real time basis reinvested profits of foreign firms as inflows of FDI and repatriated profits of foreign firms operating in China as FDI outflows. MOFCOM apparently estimates these flows based on data from the prior year. This leads MOFCOM to an underestimate of FDI when reinvestment flows are rising and an overestimate when the repatriation of earnings is increasing.
- Finally, when foreign financial institutions make direct investments in the financial sector in China, SAFE includes these transactions in its accounting of China’s FDI, MOFCOM does not.
In the figure, the four items enumerated above led to a large increase in 2021-22 in the FDI reported by SAFE relative to the MOFCOM data. But in 2022 the numbers reported by SAFE declined dramatically, while those of MOFCOM rose slightly. The result was that the two agencies reported almost identical numbers in 2022.
This pattern cannot be accounted for precisely since SAFE does not publish disaggregated FDI data. Other sources appear to show the main causes.
Proceeds from offshore IPOs in the United States alone peaked at $12.6 billion in 2021. But in late 2021 the Chinese securities regulator tightened the rules for offshore listings. And the US accounting watchdog was threatening to delist Chinese companies from the US market if it could not get access to certain auditing papers of these listed Chinese firms.
As a result of these actions, offshore listings of Chinese companies in US markets plummeted to $468 million in 2022. The US accounting watchdog announced in December 2022 that it had achieved full access to the relevant auditing documents, thus lifting the risk that Chinese firms could be kicked off US stock exchanges. And the Chinese securities regulator in March 2023 announced new regulations designed to revive offshore listings. Nonetheless, new listings in the United States languished at only $405 million in the first three quarters of 2023. Hong Kong also counts as an offshore market, and the value of IPOs there by Chinese firms in 2020 was even larger than in New York and fell by an even larger percentage by 2022.
Foreign capital raising for China-focused venture capital and private equity funds followed a similar pattern, rising from less than $15 billion in 2020 to almost $50 billion in 2021 before falling to $20 billion in 2022 and only about $5 billion in the first three quarters of 2023.
It is likely that reinvested earnings by foreign firms operating in China followed a similar pattern, but the magnitude of this reinvestment is not known. Surveys show attitudes of these companies turned increasingly cautious in recent years as geopolitical tensions with China rose and China appeared to be transitioning to much slower growth, presumably leading to less reinvestment and more repatriation of the earnings of these companies.
Finally, in the Phase One Economic and Trade Agreement China reached with the United States in January 2020, China agreed to lift existing equity limitations on foreign firms engaged in joint ventures providing banking, insurance, securities, and other financial services. This allowed foreign firms to either establish new wholly foreign-owned financial services firms or buy out their Chinese partners in existing joint ventures. In either case these foreign firms had to invest, in the case of establishing new wholly foreign-owned financial firms by purchasing Chinese government bonds, to meet the minimum capital requirements imposed by the relevant Chinese regulators.
Since these bonds can’t be traded but must be held for the life of the foreign firm, SAFE treats these funds as direct investment. SAFE also treats the funds used to buy out the ownership shares of existing local joint venture partners as direct investment. For example, JPMorgan Chase and Goldman Sachs both took over their securities joint ventures in 2021. In July 2021 the China Banking and Insurance Regulatory Commission approved Allianz Insurance Asset Management as a wholly foreign-owned insurance asset management firm. In late 2022 the same regulator approved Chubb’s expansion of its ownership stake in its joint venture insurance group from 47 to 83 percent, giving Chubb majority control.
In addition, even prior to the 2020 lifting of equity restrictions, foreign banks took ownership stakes exceeding 10 percent in several Chinese banks, which SAFE counts as direct investments. The largest seems to be HSBC’s investment in 2004 of $1.7 billion in Bank of Communications, establishing a 19.9 percent ownership position. Following the lifting of equity ownership restriction in 2020, most foreign financial firms that sought to establish new wholly foreign- owned financial firms or assume full ownership of existing joint ventures had completed such transactions in 2021 or early 2022, so these direct investments presumably fell in 2022 and 2023.
This incomplete information only partially accounts for the sharp decline in FDI reported by SAFE for 2022, suggesting that foreign firms began to sell down their FDI that year. The figure above shows that in 2022 FDI reported by SAFE was very close to the greenfield and M&A FDI reported by MOFCOM. The extra contribution to FDI of the four items not counted by MOFCOM but included in the SAFE data on FDI appears to have vanished. In the first three quarters of 2023, data reported by MOFCOM exceeded that reported by SAFE by $113 billion, implying that foreign firms had exited from more than $100 billion in direct investment.
1. If these four items were net positive in the first three quarters of 2023, then foreign firms in 2023 must have sold even more than $113 billion of their prior direct investments.
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