By Antonio Graceffo
Commentary
For three years during COVID-19, money flowed into China while almost none flowed out. Now, the trend is reversing.
Between 2014 and 2019, China experienced net capital outflows—meaning more money flowed out of the country than in. But beginning in 2020, with COVID travel restrictions and ratcheting control exerted by Chinese leader Xi Jinping, more money remained in the country. During the first two years of the pandemic, when the rest of the world was in lockdown, China continued to export, causing both a trade surplus and net cash inflows. Now, the situation has changed. During the final quarter of 2022, China experienced the first net capital outflow in over two years.
One of the largest sources of foreign capital is exports. China’s exports declined in the fourth quarter, with December exports decreasing 9.9 percent year on year. Containers began collecting at Chinese ports, and now the trend is accelerating. Stacks six to seven containers high are being reported in some ports. Beijing even confirmed the container buildup but has attributed it to “normal market adjustment” rather than a decline in exports. However, data tells a different story—exports decreased by 6-7 percent in the first two months of 2023.
Foreign direct investment (FDI), another major source of capital inflows, decreased tremendously last year. This was partly due to increased interest rates in the United States, which drew investment away from China and into the United States. Ongoing COVID restrictions in China have also added unpredictability and increased risk to the business environment. A general economic slowdown where GDP growth sank to 3 percent in 2022 from double digits, coupled with rising wages, has made Chinese investment less attractive to foreign manufacturers.
China has been steadily pricing itself out of lower-end manufacturing for some time, with average salaries rising to more than $12,000 per year. This is about three times the average salary in Vietnam or Indonesia, and almost five times the average salary in India. Faced with a myriad of disincentives, foreign companies are looking for ways to diversify away from China.
In 2022, greenfield FDI (expanding or setting up brand new businesses abroad) was down 50 percent compared to 2019. Mergers and acquisitions also declined. And FDI is down across all sectors, with some being hit harder than others. Inbound-tourism-related FDI is down 78 percent, while FDI in the food and financial services sectors is down 63 percent.
Other Asian countries—like India, Malaysia, Indonesia, and Vietnam—have benefited from the redirection of foreign investment. FDI inflows into Asia-pacific countries are expected to increase by 30 percent this year, and India is now set to become the world’s third largest FDI destination.
While less money is coming in, more money is flowing out. Chinese citizens are allowed to travel abroad again for studies, work, business, and tourism, and each will take some money with them as they go. Furthermore, there has been a trend for some time of wealthy Chinese relocating to Singapore, either because of the better education and opportunities for their children, lower taxes, or because they do not like the direction the country is heading under Xi. Now that both China and Singapore are reopened, this trend is expected to accelerate.
So far, in 2023, FDI in China has increased, with much of the investment flowing into high-tech manufacturing. However, business confidence remains low. Foreign companies saw an average 10 percent decrease in China profits last year. The European Chamber of Commerce in China has repeatedly stated that foreign companies are not leaving China outright, but they are isolating their China business as they shift new investments to other countries in Asia.
Investment from Taiwanese firms in China fell to a three-year low, and with the current political tensions, it is unclear if that investment will return. The U.S. chip ban also forces companies to relocate at least part of their manufacturing to nations unaffected by the restrictions.
In an attempt to attract investors, local governments are launching their own initiatives, including foreign roadshows like the one held by China’s Qingdao city government earlier this year in Tokyo. Last year, foreign investors dumped much of their Chinese stock holdings. But, in January, foreign investors bought up shares in record numbers.
The Chinese government bond market, which saw a 15 percent selloff by foreign investors last year, does not seem to be recovering. So far, this year, foreign investors continue to divest themselves of central government bonds. The People’s Bank of China has been keeping interest rates low as a means of stimulating the economy. But low rates make Chinese bonds unattractive, particularly when U.S. interest rates continue to rise.
Beijing is taking steps to curb capital outflows by enacting legislation that prevents some brokerages from opening new accounts to move Chinese money into foreign stocks. The China Securities Regulatory Commission announced regulations to prevent “illegal cross-border securities businesses,” closing one of the last remaining loopholes that citizens could use to get their money out of China.
Foreigner and Chinese retail customers report having trouble removing or transferring money from Chinese banks, although officials claim that there have been no changes in policy. Professional investor Mark Mobius reported that he could not withdraw money from an HSBC account in Shanghai.
The general economy is expected to fare much better this year with a 5 percent GDP growth target. But, for now, it seems that low-interest rates will continue to keep foreign investors out of the government bond market, while a decline in exports will reduce the amount of foreign capital flowing in. Beijing is tightening the noose on capital outflows and is making China even less attractive as a destination for foreign direct investment.
