China suffered its first-ever quarterly deficit in foreign direct investment during the July to September period, as foreign companies on the mainland continue to redirect profits to more appealing investment destinations.
Preliminary data on China’s balance of payments released late on Friday showed direct investment liabilities stood at a deficit of $11.8 billion in the third quarter of this year.
This was the first quarterly shortfall since China’s foreign exchange regulator – which does not distinguish between new foreign investment or reinvested profits – began recording international transactions in 1998.
The Financial Times reported last week that foreign direct investment (FDI) in China had plunged by double-digit amounts in every month since May and 34% in September.
But the outflows actually started after the notorious Covid lockdowns in Shanghai in the second quarter of last year. Foreign firms had pulled more than $160 billion out of the country over the 18 months to the end of September, instead of reinvesting those profits, the Wall Street Journal said.
Analysts say there are simple reasons why China has endured this prolonged period of capital outflows, such as higher interest rates in the US and Europe making it more appealing to park their earrings in the West, while central banks raise rates to fight inflation.
The other key factors were China’s faltering economic recovery, and calls by Western governments for companies to “de-risk” their supply chains amid growing geopolitical tensions.
Surveys of foreign executives have shown they fear the prospect of war over Taiwan and have been worried by Beijing’s efforts to expand its oversight of foreign entities and consulting firms.
This has driven foreign investment in China to a two-decade low.
US Commerce Secretary Gina Raimondo said during a visit to China in August that US companies had complained to her that China had become “uninvestible.
Foreign investors, meanwhile, have pulled over $110 billion from Chinese bonds since the beginning of last year and $23 billion from shares in Hong Kong and exchanges on the mainland, according to the data provider Wind.
All of this shows the challenge that Beijing now faces attracting foreign investment, while interest rate differentials remain so far apart.
It may also be a reason why President Xi is seeking to re-engage with the West – meeting with Australian PM Albanese today and due to meet with Biden in San Francisco next week.
Capital outflow pressures
“Some of the weakness in China’s inward FDI may be due to multinational companies repatriating earnings,” Goldman Sachs said, adding that China’s interest-rate differentials with developed countries also played a part.
“With interest rates in China ‘lower for longer’ while interest rates outside of China ‘higher for longer’, capital outflow pressures are likely to persist.”
As a result, China’s basic balance – which encompasses current account and direct investment balances and are more stable than volatile portfolio investments – recorded a deficit of $3.2 billion, the second quarterly shortfall on record.
“Given these unfolding dynamics, which are poised to exert pressure on the RMB, we anticipate a sustained strategic response from China’s authorities,” Tommy Xie, head of Greater China Research at OCBC wrote.
Record low yuan-dollar trading last month
Onshore yuan trading against the dollar also hit record-low volume in October, official data showed, highlighting authorities’ stepped-up efforts to curb yuan selling.
Xie expects China’s central bank to continue counter-cyclical interventions – including a strong bias in daily yuan fixings and managing yuan liquidity in the offshore market – to support the currency in the face of these headwinds.
Latest data shows that onshore volume of yuan trading against the dollar slumped to a record low of 1.85 trillion yuan ($254.05 billion) in October, a 73% drop from the August level.
The People’s Bank of China has urged major banks to limit trading and dissuade clients to exchange the yuan for the dollar, sources have told Reuters.
In September, foreign exchange outflows from China rose sharply to $75 billion, the biggest monthly figure since 2016, Goldman Sachs data showed.
- Jim Pollard with Reuters
NOTE: This report was updated with further details on November 6, 2023.