Alicia García Herrero (Natixis) | China has long been a focal point for global companies, European ones included. However, a shift seems to be happening with foreign direct investment (FDI) into China, as it is now plummeting rather than booming. In fact, China’s inward FDI has turned to negative growth for the first time in 25 years.
Several questions seem warranted when exploring this phenomenon. Firstly, the deceleration of FDI in 2022 could have been explained by the strict zero-Covid policies that year, but it is much harder to explain why the downward trend has continued to this day, even after China’s reopening from Covid lockdowns. Secondly, the reaction of Chinese authorities appears somewhat contradictory. On the one hand, China’s leadership does not miss opportunities to announce further opening up of the economy, yet keeps cracking down on multiple sectors and introducing increasingly tough legislation for foreign companies. Examples of this include the anti-foreign espionage law and the very strict regulations for data to be transferred out of China.
When looking into the interest of European investors in China, views are clearly heterogenous. Large European companies which entered the Chinese market very early are keen to continue to operate in China. The large stock of investment that they have accumulated in China warrants it, even if the business prospects are much less appealing. Amidst this, the companies are increasingly worried about the EU’s de-risking agenda as they could be subject to retaliation. A second group of companies which are present in China, but for which China is not their most crucial market, are diversifying their exposure away from China, under the so-called China+1 strategy.
A third and final group of European companies which are losing interest for the Chinese markets are small and medium enterprises (SMEs). The reasons for this are mostly related to the growing regulatory complexities of the Chinese market which an SME cannot address or, at least, not in a cost-effective way. Some of the regulatory changes stem from China’s own decisions, especially as far as digitalisation and data security are concerned. However, other reasons for complexity are intrinsically linked to the US-China great power competition and the measures the two countries have put in place to protect their economies from each other. This is particularly true for companies producing dual technology, whether small or large.
All in all, 75 percent of respondents to the recently published EU Business Confidence Survey on China for 2024 are seeing shrinking profitability, with as much as 40 percent losing market share and 50 percent facing overcapacity.
The rapid slowdown of FDI into China seems like a logical outcome. Chinese companies are also quite happy to embark in China+1strategy as it allows them to bypass tariffs imposed on Chinese goods. This is especially the case for consumer electronics, appliances and white goods which were hit by Trump’s tariffs in 2018. However, green tech Chinese companies are now hit hard by new measures introduced by the US, such as tariffs and a lack of access to US subsidies under the Inflation Reduction Act. The fear of reduced market access in the EU, given the several investigations that the EU is pursuing on Chinese subsidies, is also pushing Chinese companies to shift part of their production to Europe or areas which have free trade agreements with Europe.
China’s key comparative advantage, namely that of attracting and retaining the best companies, is changing because of the reluctance of foreign investors to operate in China (unless they are already too dependent on this market) and because Chinese companies have also begun to move overseas. Companies will not necessarily leave China, as the market is still too large to ignore, but rather they might need to find alternative venues for production as well as for market access.
US-China strategic competition is an important reason for this evolution, but it is not the only one. Even in sectors where that competition is not essential, China is losing ground in terms of attracting FDI. The reason is very simple: growth continues to decelerate in China and, with it, the business opportunities. Beyond growth, deflationary pressures do not help keep the margins so companies simply cannot envisage the same opportunities as they would have had in the past. If we finally add China’s much harsher regulation for foreign companies, what may seem like a puzzle – China’s plummeting inward FDI – becomes easier to understand.
European investors in China are facing weak demand, more competition and tougher regulations
