Global corporations have invested hundreds of billions of dollars to buy and establish factories in China since Deng Xiaoping opened the country to foreign investment in 1978 in order to get access to the market and access to cheap labour, supporting the Chinese yuan.

The possibility that the long-term trend is changing is increased by the fact that a gradual decline in foreign direct investment gave way to a sharp decline last quarter and inflows to China plunged to their lowest levels since records began 25 years ago.

Corporate executives and their advisors claim that a change is already underway and that long-term political considerations drive investment choices, putting the yuan under pressure from one of its most ardent supporters.

“FDI has historically not been a huge swing factor in the exchange rate’s value, because you typically had surpluses of $50 to $100 billion a year,” said Logan Wright, director of China Markets Research at analytics firm Rhodium Group.

“But when that swings to a deficit, which is where it is right now … that’s a pretty big adjustment.”

According to data released last week by China’s State Administration of Foreign Exchange (SAFE), foreign direct investment (FDI) inflow decreased to less than $4.9 billion for the second quarter while Chinese companies’ operations abroad caused net direct investment to record a record deficit of $34.1 billion.

Investors and economists claim that the fall is the result of firms’ trepidation regarding the trajectory of political and economic conflict between China and the West, which has already resulted in trade and investment restrictions as well as a chill in diplomatic relations.

The Biden administration is expected to enact new outbound investment restrictions for China in the coming weeks, according to reports citing sources. China has retaliated by stifling raw material exports while being prohibited from purchasing high-tech chipmaking gear from corporations in Japan, the United States, and Europe.

Aside from diplomatic issues, Beijing’s tight “zero-COVID” policy of lockdowns and quarantines that interrupted supply chains and manufacturing processes had already weakened company trust.

Businesses were alarmed by China’s regulatory crackdowns on particular industries and raids on American consulting firms, which made them wonder when and where the next blow might come from.

“I don’t have one client wanting to invest in China. Not a single client,” said John Ramig, partner at law firm Buchalter, who specialises in international business deals and structuring of manufacturing.

“Everyone is looking to either sell their Chinese operation, or if they’re sourcing products in China, they’re looking for an alternative place to do that,” he said. “That’s dramatically different from what it was even five years ago.”

The greenfield flows into new production capacity, according to Oxford Economics’ experts, have been declining for years and will only amount to $18 billion in 2022 from averaging approximately $100 billion annually in 2010–2011.

The decline in China’s FDI has caught people’s attention since it has long been assumed to be a given in international trade, and its unravelling portends more significant changes.

Companies’ expenditure, while cyclical, tends to be stickier and steadier as enterprises develop and grow production, suggesting economic effects are probable when it unravels, in contrast to more erratic portfolio flows from investors.

The exchange rate is already under pressure.

According to the most recent SAFE data, dollar purchases through Chinese banks for outbound direct investment have consistently outpaced yuan purchases for foreign incoming investment this year, leading to six straight months of outflows.

Data from the Ministry of Commerce, which revealed that paid-in FDI decreased 5.6% during the first five months of the year, the largest decrease in three years, further supported this trend.

The yuan has only found support as the central bank has led its trading range off lows and state banks have been purchasing in the spot market. The yuan is down around 4% against the dollar this year, despite the U.S. currency falling abroad.

Unpredictable investment flows do exist, and many businesses are either not leaving China at all or only partially.

Daniel Seeff tried to move production from Haining in the Yangtze River delta to Peru but was unable to match the quality and cost of his China factory. Daniel Seeff’s sock manufacturing company Foot Cardigan was affected by tariffs and COVID logistical issues.

“For now, I don’t think that China has lost this edge for us,” he said. Such flows are only one aspect of the yuan’s path, according to Chi Lo, senior investment strategist at BNP Paribas Asset Management in Hong Kong, and the currency can maintain its strength.

However, the data indicates that enough companies in China are making decisions to stop operations or refrain from expanding their capacity, which will determine how capital will flow for years to come.

“The political atmosphere is incentivising western companies away from China … because the benefits of being in China are not outweighing the risks,” said Lee Smith, global trade attorney at Baker Donelson.

“A lot of our clients are worried about their exposure to China as a sole country of supply.”

(Adapted from FlipBoard.com)

Categories: Economy & Finance, Geopolitics, Regulations & Legal, Strategy, Uncategorized