Is investment capital fleeing China?

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Is investment capital fleeing China?

(People's Daily Online) 14:00, August 15, 2013

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Economists and analysts say it’s not easy to quantify the level of foreign investment which is currently flowing out or has flown out of the Chinese mainland.

Data from China’s foreign exchange regulator shows that the country’s capital and financial account turned negative in 2012, indicating a net financial outflow. The account deficit was subsequently revised to 16.8 billion U.S. dollars.

“It’s hard to tell whether the funds flowing out of China are Chinese or foreign,” said Tan Yaling, director of China Forex Investment Research Institute, “Chinese enterprises and private investors have shown greater interest in overseas assets since the price falls following the downturn of the global economy in 2008.”

“From what we’re seeing now, some foreign capital is leaving to seek higher returns elsewhere, but China still ranks second in the world in terms of attracting foreign investment,” explained He Maochun, director of the Research Center for Economic Diplomacy Studies at Tsinghua University.

Driven by increasing market expectations on the Fed’s exit from quantitative easing, there are signs that foreign capital is gradually withdrawing from emerging economies. But this exodus of foreign capital has yet to have a serious impact in China, according to an official from China’s State Administration of Foreign Exchange who spoke in July.

Chinese economists believe there is media hype behind arguments overstating the investment risk in China. A considerable amount of negative talk is coming from Japan, the second largest source of China’s foreign capital, according to the analysis of Yuan Tangjun, associate professor of Department of World Economy at Fudan University.

Why is disinvestment happening?

The majority of the capital outflow is caused by short-term investment adjustments, while some is moving out as a result of government policy changes or under the pressure of rising operating costs.

Higher labor costs and fewer preferential policies are the major disincentives to foreign enterprises. The basic wage in China increased for four successive years between 2009 and 2012. In the first half of 2012, the average wages of urban Chinese rose by 13 percent year-on-year, and those of migrant workers by 14.9 percent.

Is an outflow of foreign capital necessarily bad for the Chinese economy? Experts say it depends on what kind of money it is. If it is ‘hot money’, the outflow is beneficial.

“Hot money earns short-term profits. The entrance of large amounts of hot money can cause big trouble. Governments are cautious about the influx of hot money because of the heavy pressure of rapid currency appreciation and inflation it brings,” said Hua Min, director of the World Economy Institute at Fudan University.

China should be alert to any outflows of investment capital in the real economy, suggested Lu Zhengwei, chief economist of Societe Generale.

But a withdrawal from some industries does not represent the overall course of foreign capital outflow. Government needs to channel foreign investment into the emerging industries that the country supports, said He Maochun.

Is China still attractive to foreign investment?

The outflow of foreign funds doesn’t mean China is no longer an attractive destination for foreign investors, says Song Songyi, professor of business at Nanjing University. Despite cost pressures partly attributable to the wage hike, “in the short term, low costs in second-and third-tier Chinese cities will be more attractive to foreign investors, which means that foreign currency will continue to find a home in China.”

“China’s huge domestic market has replaced cheap land and a low-cost labor force in becoming the major attraction. Foreign investors do indeed have to pay more for labor now, but in return the quality the Chinese workforce is up, and it is able to undertake higher value-added processing work,” said Lu Zhengwei.

The trend appears to be for the number of foreign-funded enterprises to decline, while the actual use of foreign capital by contrast is growing.

China’s commerce ministry data showed that the number of newly established foreign-funded enterprises shrunk in June by 17.31 percent year-on-year, but the actual use of foreign capital climbed 20.12 percent.

Another significant trend is for foreign investment to explore new geographical areas and new business sectors in China. In the first half year of 2013, foreign direct investment (FDI) in the western area grew by 32.54 percent year-on-year, while in the eastern part of the country, which used to be the most attractive destination, it increased by only 1.69 percent.

The service sector has outperformed manufacturing in terms of absorbing FDI. 40 percent of foreign investment went to the service sector in the first half year of 2013, representing 30.63 billion U.S. dollars. This was 7 percent more than the manufacturing sector.

Mei-Wei Chen, President and CEO of Siemens China, said that this indicates economic transformation is taking place, and that foreign investors must prepare for and adjust to it.